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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**x****     ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2010**

 

**OR**

 

**o****        ****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom             to             **

 

**Commissionfile number: 1-32551**

 

**DEERFIELD CAPITAL CORP.**

(Exact name of registrant as specified in its charter)

 

| **Maryland**             | ** ** | **20-2008622**      |
|--------------------------|------------|---------------------|
| (State of incorporation) |       | (I.R.S. Employer    |
|                     |       | Identification No.) |

 

**6250 NorthRiver Road, 12th Floor, Rosemont, Illinois 60018**

**(773) 380-1600**

(Address, including zip code, and telephone number,

including area code, of registrant’s principal executive offices)

 

**6250 NorthRiver Road, 9th Floor, Rosemont, Illinois 60018**

(Former name, former address and former fiscal year, if changed sincelast report)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to be submittedand posted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).  Yes o No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o No x

 

Therewere 6,455,357 shares of the registrant’s Common Stock outstanding as of May 14,2010.

 

 

 

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**DEERFIELDCAPITAL CORP.**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE QUARTER ENDED MARCH 31, 2010**

 

**INDEX**

 
| ** **                                                                                                      | **Page** |
|-----------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                            |     |
| Part I. Financial Information                                                                              |     |
|                                                                                                            |     |
| Item 1.  Condensed Consolidated Financial Statements and Notes (Unaudited)                                 | 6        |
|                                                                                                            |     |
| Condensed Consolidated Balance Sheets — March 31,  2010 and December 31, 2009                    | 6        |
|                                                                                                            |     |
| Condensed Consolidated Statements of Operations —  Three Months Ended March 31, 2010 and 2009         | 7        |
|                                                                                                            |     |
| Condensed Consolidated Statement of Stockholders’  Equity (Deficit) — Three Months Ended March31,2010 | 8        |
|                                                                                                            |     |
| Condensed Consolidated Statements of Cash Flows —  Three Months Ended March 31, 2010 and 2009         | 9        |
|                                                                                                            |     |
| Notes to Condensed Consolidated Financial Statements                                                            | 10       |
|                                                                                                            |     |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations       | 33       |
|                                                                                                            |     |
| Item 3. Quantitative and Qualitative Disclosures  About Market Risk                                        | 70       |
|                                                                                                            |     |
| Item 4. Controls and Procedures                                                                            | 72       |
|                                                                                                            |     |
| Part II. Other Information                                                                                 |     |
|                                                                                                            |     |
| Item 1A. Risk Factors                                                                                      | 73       |
|                                                                                                            |     |
| Item  5. Other Information                                                                                      | 73       |
|                                                                                                            |     |
| Item 6. Exhibits                                                                                           | 73       |
|                                                                                                            |     |
| Signatures                                                                                                      | 74       |

 

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**CERTAIN DEFINITIONS**

 

Unless otherwise noted orthe context otherwise requires, we refer to Deerfield Capital Corp. as “DFR,”to DFR and its subsidiaries as “we,” “us,” “our” or “our company,” to Deerfield &Company LLC, one of our indirect wholly-owned subsidiaries, as “Deerfield”and to Deerfield Capital Management LLC, our former external manager andanother of our indirect wholly-owned subsidiaries, as “DCM.” We refer to ouracquisition of Deerfield pursuant to a merger agreement, dated as of December 17,2007, among us, DFR Merger Company, LLC (our wholly-owned subsidiary thatwas merged into Deerfield), Deerfield and Triarc Companies, Inc., orTriarc (as sellers’ representative), by which DFR Merger Company, LLC wasmerged with and into Deerfield on December 21, 2007, as the “Merger.”

 

**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Certain statements in thisquarterly report on Form 10-Q, (“Quarterly Report”) and the informationincorporated by reference into this Quarterly Report are forward-looking aspermitted by the Private Securities Litigation Reform Act of 1995. Theseinclude statements regarding future results or expectations. Forward-lookingstatements can be identified by forward-looking language, including words suchas “believes,” “anticipates,” “expects,” “estimates,” “intends,” “may,” “plans,”“projects,” “will” and similar expressions, or the negative of these words.Such forward-looking statements are based on facts and conditions as they existat the time such statements are made. Forward-looking statements are also basedon predictions as to future facts and conditions, the accurate prediction ofwhich may be difficult and involve the assessment of events beyond our control.Forward-looking statements are further based on various operating assumptions.Caution must be exercised in relying on forward-looking statements. Due toknown and unknown risks, actual results may differ materially from expectationsor projections. We do not undertake any obligation to update any forward-lookingstatement, whether written or oral, relating to matters discussed in thisQuarterly Report, except as may be required by applicable securities laws. Allfuture written and oral forward-looking statements attributable to us or anyperson acting on our behalf are expressly qualified in their entirety by thecautionary statements contained or referenced above. In addition, it is ourpolicy generally not to make any specific projections as to future earnings,and we do not endorse any projections regarding future performance that may bemade by third parties.

 

The following factors, amongothers, could cause actual results to differ materially from those described inthe forward-looking statements:

 

**Relating toour business generally:**

 

·**                 **effects of therecent dislocation and weakness in the mortgage market and credit marketsgenerally;

 

·                  effects of therecent global economic crisis and recession;

 

·                  effects ofleverage and indebtedness on our assets and performance;

 

·                  failure tocomply with covenants contained in the agreements governing our indebtednessand failure to obtain waivers for future non-compliance;

 

·                  limitations andrestrictions contained in instruments and agreements governing ourindebtedness;

 

·                  our ability tomaintain adequate liquidity, including our ability to raise additional capitaland secure additional financing;

 

·                  our ability tomaintain compliance with the continued listing standards of the NASDAQ StockMarket LLC (the “NASDAQ”) and to maintain the listing of our securities ona national securities exchange;

 

·                  our ability togenerate earnings or raise capital to maintain positive stockholders’ equity;

 

·                  rapid changesin the fair values of our assets, making it difficult for us to comply with ourexemption from registration under the Investment Company Act of 1940, asamended (“1940 Act”);

 

·                  increases inborrowing costs relative to interest received on our assets;

 

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·                  the costs andeffects of the current Securities and Exchange Commission (“SEC”) investigationinto certain mortgage securities trading procedures in connection with whichthe SEC has requested information from DFR and DCM regarding certain mortgagesecurities trades of ours;

 

·                  changes instrategy, including investment strategy;

 

·                  effect of thecurrent market conditions on management fees and equity cash flows fromcollateralized debt obligations (“CDOs”);

 

·                  loss of keypersonnel, most of whom are not bound by employment agreements;

 

·                  our ability toenter into, and the effects of, any potential strategic transaction;

 

·                  adverse changesin accounting principles, tax laws or legal or regulatory requirements;

 

·                  failure tocomply with applicable laws and regulations;

 

·                  liabilityresulting from actual or potential future litigation;

 

·                  the costs,uncertainties and other effects of legal and administrative proceedings;

 

·                  the costs ofobtaining, and the potential inability to obtain, necessary or prudentinsurance to cover our business operations;

 

·                  the impact ofcompetition; and

 

·                  actions ofdomestic and foreign governments and the effect of war or terrorist activity.

 

**Relating to our Investment Management segment:**

 

·**                 **continuedreductions in assets under management (“AUM”) and related reductions in ourinvestment advisory fee revenue, due to such factors as weak investmentperformance, substantial illiquidity or price volatility in the fixed incomeinstruments in which we invest, loss of key portfolio management or otherpersonnel (or lack of availability of additional key personnel if needed forexpansion), reduced investor demand for the types of investment products thatwe offer or loss of investor confidence due to weak investment performance,volatility of returns, general declines in economic conditions and adversepublicity;

 

·                  non-renewal orearly termination of investment management agreements or removal of DCM asinvestment manager pursuant to the terms of such investment managementagreements;

 

·                  pricingpressure on the advisory fees that we can charge for our investment advisoryservices;

 

·                  our ability toassume or otherwise acquire additional CDO management contracts on favorableterms, or at all;

 

·                  difficulty inincreasing AUM, or efficiently managing existing AUM, due to market-relatedconstraints on trading capacity, inability to hire the necessary additional orreplacement personnel or lack of potentially profitable trading opportunities;

 

·                  the reductionin CDO management fees or AUM resulting from payment defaults by issuers of theunderlying collateral, downgrades of the underlying collateral by the ratingagencies or depressed market values of the underlying collateral, all of whichmay contribute to the triggering of certain structural provisions and/or eventsof default built into CDOs;

 

·                  our inability,due to market conditions, to launch CDO or other investment vehicles, whichprovide us with investment management fee revenue;

 

·                  liabilityrelating to our failure to comply with investment guidelines set by our clientsor the provisions of the management and other agreements; and

 

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·                  changes inlaws, regulations or government policies affecting our business, including investmentmanagement regulations and accounting standards.

 

**Relating to our Principal Investing segment:**

 

·**                 **impact ofchanges in our strategy surrounding the composition and decreased size of ourinvestment portfolio;

 

·                  a decrease inthe value of our mortgage portfolio resulting in higher counterparty margincalls and decreased liquidity;

 

·                  effects ofdefaults or terminations under repurchase transactions, interest rate swaps andlong term debt obligations;

 

·                  the impact onour investments and business strategy resulting from conservatorship of theFederal National Mortgage Association (“Fannie Mae”) and the Federal Home LoanMortgage Corporation (“Freddie Mac”) and related efforts, along with anychanges in laws and regulations affecting the relationship between Fannie Maeand Freddie Mac and the U.S. government;

 

·                  effects ofhaving all of our repurchase transactions concentrated with two counterparties;

 

·                  higher or lowerthan expected prepayment rates on the mortgages underlying our residentialmortgage backed securities (“RMBS”) portfolio;

 

·                  illiquid natureof certain of the assets in our investment portfolio;

 

·                  increased ratesof default on our investment portfolio (which risk rises as the portfolioseasons) and decreased recovery rates on defaulted loans;

 

·                  our inabilityto obtain the financing needed to leverage our RMBS and other portfolios andour inability to obtain favorable interest rates, margin or other terms on anysuch financing;

 

·                  flattening orinversion of the yield curve (a decreased differential between long and shortterm interest rates) reducing our net interest income on our financed mortgagesecurities positions;

 

·                  our inabilityto adequately hedge or our decision to not fully hedge our holdings that aresensitive to changes in interest rates;

 

·                  narrowing ofcredit spreads, thus decreasing our net interest income on future creditinvestments (such as bank loans);

 

·                  concentrationof investment portfolio in adjustable-rate RMBS;

 

·                  effects ofinvesting in equity and mezzanine securities of CDOs; and

 

·                  effects ofinvesting in the debt of middle market companies.

 

**Relatingto the Acquisition and the Stock Issuances (each as defined below):**

 

·                  our inabilityto integrate Columbus Nova Credit Investments Management, LLC (“CNCIM”) intoour business successfully and the amount of time and expense spent and incurredin connection with the integration;

 

·                  failure to realize the economic benefits that weanticipate as a result of the acquisition of all of the outstanding equityinterest in CNCIM from Bounty Investments, LLC (the “Acquisition”) ;

 

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·                  failure to uncover all risks and liabilitiesassociated with the Acquisition;

 

·                  impacts of the issuance of $25 million inaggregate principal amount of our senior subordinated convertible notes (the “ConvertibleNotes”) and the use of proceeds thereof, including its impact on our liquidity,ability to raise additional capital and financial condition;

 

·                  impacts of the issuances of our common stock inconnection with the Acquisition and any conversion of the Convertible Notes(the “Stock Issuances”), including dilution of the ownership of the our commonstock;

 

·                  failure to obtain any necessary third party consentsor satisfy any of the other conditions of the Acquisition;

 

·                  effects on the market price of our common stock and onour operating results because of a failure to complete the Acquisition and theStock Issuances;

 

·                  impacts of the Stock Issuances on our ability to useour net operating losses, net capital losses and certain recognized built-inlosses to offset future taxable income and gains; and

 

·                  effects of reduction in management fees or AUM fromthe CLOs managed by CNCIM resulting from payment defaults by issuers of theunderlying collateral, downgrades of the underlying collateral by the ratingagencies or depressed market values of the underlying collateral, all of whichmay contribute to the triggering of certain structural provisions and/or eventsof default built into CLOs.

 

These and other factorscould cause our actual results to differ materially from those described in theforward looking statements set forth in our annual report on Form 10-K forthe year ended December 31, 2009, including those factors set forth in ourannual report under the heading “*Risk Factors*”as well as other factors set forth in this Quarterly Report and our otherpublic filings with the SEC and public statements.  Readers of this Quarterly Report arecautioned to consider these risks and uncertainties and not to place unduereliance on any forward-looking statements.

 

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**DEERFIELDCAPITAL CORP. AND ITS SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

** **
| ** **                                                                                                            | ** ** | **March 31,**              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-----------------------|------------|
| ** **                                                                                                            | ** ** | **2010**                        | ** ** | **2009**              | ** ** |
| ** **                                                                                                            | ** ** | **(In thousands, except share** | ** ** |
| ** **                                                                                                            | ** ** | **and per share amounts)**      | ** ** |
| **ASSETS**                                                                                                            | ** ** | ** **                      | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                                                                            |       | $                               | 36,289     |                  | $          | 48,711 |   |
| Due from broker                                                                                                       |       | 5,021                           |       | 14,606                |       |
| Restricted cash  and cash equivalents                                                                                 |       | 29,451                          |       | 19,296                |       |
| Investments at  fair value, including $285,799 and $303,763 pledged                                                   |       | 313,230                         |       | 326,810               |       |
| Other  investments                                                                                                    |       | 1,345                           |       | 4,287                 |       |
| Derivative  assets                                                                                                    |       | 26                              |       | 74                    |       |
| Loans held for  sale                                                                                                  |       | 517                             |       | 536                   |       |
| Loans held for  investment                                                                                            |       | 276,609                         |       | 278,585               |       |
| Allowance for  loan losses                                                                                            |       | (12,764)                        |       | (15,889)              |       |
| Loans held for  investment, net of allowance for loan losses                                                          |       | 263,845                         |       | 262,696               |       |
| Investment  advisory fee receivables                                                                                  |       | 1,154                           |       | 2,117                 |       |
| Interest  receivable                                                                                                  |       | 3,208                           |       | 3,420                 |       |
| Other receivable                                                                                                      |       | 28,426                          |       | 2,890                 |       |
| Prepaid and  other assets                                                                                             |       | 8,220                           |       | 7,043                 |       |
| Fixed assets,  net                                                                                                    |       | 2,368                           |       | 6,505                 |       |
| Intangible  assets, net                                                                                               |       | 19,781                          |       | 21,231                |       |
| Assets held in  Consolidated Investment Products:                                                                     |       |                            |       |                  |       |
| Due from broker                                                                                                       |       | 10,746                          |       | —                |       |
| Restricted cash  and cash equivalents                                                                                 |       | 160,392                         |       | —                |       |
| Investments at  fair value                                                                                            |       | 2,199,578                       |       | —                |       |
| Derivative  assets                                                                                                    |       | 25                              |       | —                |       |
| Interest  receivable                                                                                                  |       | 10,111                          |       | —                |       |
| Other receivable                                                                                                      |       | 2,496                           |       | —                |       |
| Total assets  held in Consolidated Investment Products                                                                |       | 2,383,348                       |       | —                |       |
| TOTAL ASSETS                                                                                                          |       | $                               | 3,096,229  |                  | $          | 720,222 |   |
|                                                                                                                  |       |                            |       |                  |       |
| **LIABILITIES**                                                                                                       |       |                            |       |                  |       |
| Repurchase  agreements, including $26 and $34 of accrued interest                                                     |       | $                               | 277,623    |                  | $          | 291,463 |   |
| Due to broker                                                                                                         |       | 16,904                          |       | 803                   |       |
| Derivative  liabilities                                                                                               |       | 236                             |       | 450                   |       |
| Redemptions  payable                                                                                                  |       | 9,145                           |       | —                |       |
| Interest payable                                                                                                      |       | 647                             |       | 1,103                 |       |
| Accrued and  other liabilities, including $312 and $364 at fair value                                                 |       | 4,276                           |       | 6,214                 |       |
| Long term debt                                                                                                        |       | 410,524                         |       | 413,329               |       |
| Liabilities held  in Consolidated Investment Products:                                                                |       |                            |       |                  |       |
| Due to broker                                                                                                         |       | 59,328                          |       | —                |       |
| Derivative  liabilities                                                                                               |       | 10,472                          |       | —                |       |
| Interest payable                                                                                                      |       | 3,451                           |       | —                |       |
| Long term debt                                                                                                        |       | 2,069,394                       |       | —                |       |
| Total  liabilities held in Consolidated Investment Products                                                           |       | 2,142,645                       |       | —                |       |
| TOTAL  LIABILITIES                                                                                                    |       | 2,862,000                       |       | 713,362               |       |
|                                                                                                                  |       |                            |       |                  |       |
| **STOCKHOLDERS’  EQUITY**                                                                                        |       |                            |       |                  |       |
| Preferred stock,  par value $0.001:                                                                                   |       |                            |       |                  |       |
| 100,000,000  shares authorized; 14,999,992 shares issued and zero outstanding                                         |       | —                          |       | —                |       |
| Common stock,  par value $0.001:                                                                                      |       |                            |       |                  |       |
| 500,000,000  shares authorized; 6,455,357 and 6,455,357 shares issued and 6,455,357 and  6,454,924 shares outstanding |       | 6                               |       | 6                     |       |
| Additional  paid-in capital                                                                                           |       | 867,095                         |       | 866,557               |       |
| Accumulated  other comprehensive loss                                                                                 |       | (110)                           |       | (87)                  |       |
| Accumulated  deficit                                                                                                  |       | (877,292)                       |       | (877,155)             |       |
| Appropriated  retained earnings related to noncontrolling interest                                                    |       | 235,455                         |       | —                |       |
| Noncontrolling  interest in consolidated entity                                                                       |       | 9,075                           |       | 17,539                |       |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                      |       | 234,229                         |       | 6,860                 |       |
|                                                                                                                  |       |                            |       |                  |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                      |       | $                               | 3,096,229  |                  | $          | 720,222 |   |

 

See notes to condensed consolidated financial statements.

 

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**DEERFIELDCAPITAL CORP. AND ITS SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

** **
| ** **                                                                             | ** ** | **Three months ended March 31,**                  | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2010**                                               | ** ** | **2009** | ** ** |
| ** **                                                                             | ** ** | **(In thousands, except share and per share amounts)** | ** ** |
| **Revenues**                                                                           |       |                                                   |       |   |   |
| Interest income                                                                        |       | $                                                      | 31,502     |   | $ | 13,782 |   |
| Interest expense                                                                       |       | 7,694                                                  |       | 6,999 |   |
| Net interest  income                                                                   |       | 23,808                                                 |       | 6,783 |   |
| Provision for  loan losses                                                             |       | 4,186                                                  |       | 2,107 |   |
| Net interest  income income after provision for loan losses                            |       | 19,622                                                 |       | 4,676 |   |
| Investment  advisory fees                                                              |       | 2,896                                                  |       | 4,737 |   |
| Total net  revenues                                                                    |       | 22,518                                                 |       | 9,413 |   |
|                                                                                   |       |                                                   |       |   |   |
| **Expenses**                                                                           |       |                                                   |       |   |   |
| Compensation and  benefits                                                             |       | 2,841                                                  |       | 3,354 |   |
| Professional  services                                                                 |       | 2,288                                                  |       | 790 |   |
| Insurance  expense                                                                     |       | 692                                                    |       | 764 |   |
| Other general  and administrative expenses                                             |       | 1,911                                                  |       | 946 |   |
| Depreciation and  amortization                                                         |       | 5,738                                                  |       | 1,635 |   |
| Occupancy                                                                              |       | 490                                                    |       | 639 |   |
| Cost savings  initiatives                                                              |       | —                                                 |       | 197 |   |
| Impairment of  intangible assets                                                       |       | 168                                                    |       | — |   |
| Total expenses                                                                         |       | 14,128                                                 |       | 8,325 |   |
|                                                                                   |       |                                                   |       |   |   |
| **Other  Income and Gain (Loss)**                                                      |       |                                                   |       |   |   |
| Net loss on  available-for-sale securities                                             |       | —                                                 |       | (31) |   |
| Net gain on  investments at fair value                                                 |       | 73,032                                                 |       | 5,138 |   |
| Net loss on  liabilities at fair value                                                 |       | (87,855)                                               |       | — |   |
| Net gain on  loans                                                                     |       | 2,754                                                  |       | 5,815 |   |
| Net loss on  derivatives                                                               |       | (667)                                                  |       | (404) |   |
| Dividend income  and other net (loss) gain                                             |       | 1,046                                                  |       | (49) |   |
| Net other income  and gain (loss)                                                      |       | (11,690)                                               |       | 10,469 |   |
| Income (loss)  before income tax expense                                               |       | (3,300)                                                |       | 11,557 |   |
| Income tax  expense                                                                    |       | —                                                 |       | 18 |   |
|                                                                                   |       |                                                   |       |   |   |
| **Net  income (loss) attributable to common stockholders**                             |       | (3,300)                                                |       | 11,539 |   |
| Net loss  attributable to noncontrolling interest                                      |       | 3,163                                                  |       | — |   |
| **Net  income (loss) attributable to Deerfield Capital Corp.**                         |       | $                                                      | (137)      |   | $ | 11,539 |   |
|                                                                                   |       |                                                   |       |   |   |
| **Net  income (loss) attributable to Deerfield Capital Corp.****per  share - basic**   |       | $                                                      | (0.02)     |   | $ | 1.72 |   |
| **Net  income (loss) attributable to Deerfield Capital Corp.****per  share - diluted** |       | $                                                      | (0.02)     |   | $ | 1.72 |   |
|                                                                                   |       |                                                   |       |   |   |
| WEIGHTED-AVERAGE  NUMBER OF SHARES OUTSTANDING - BASIC                                 |       | 6,763,098                                              |       | 6,702,329 |   |
| WEIGHTED-AVERAGE  NUMBER OF SHARES OUTSTANDING - DILUTED                               |       | 6,763,098                                              |       | 6,702,329 |   |

 

See notes to condensed consolidated financial statements.

 

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**DEERFIELDCAPITAL CORP. AND ITS SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (UNAUDITED)**
| ** **                                                                               |       |                                      |       |           |       |        |       |              |       |                |       |                       |       |               |       |       |       |              |       |   |   |   |    |   |   |    |   |
|------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|----------------|------------|-------------|------------|-------------------|------------|---------------------|------------|----------------------------|------------|--------------------|------------|------------|------------|-------------------|------------|--------|--------|--------|---------|--------|--------|---------|--------|
| ** **                                                                               |       | **Deerfield  Capital Corp. Stockholders** |       | ** **     |       |        |       |              |       |                |       |
| ** **                                                                               |       |                                      |       |           |       |        |       | ** **        |       |                |       | **Appropriated**           |       |               |       |       |       |              |       |
| ** **                                                                               | ** ** | ** **                                | ** ** | ** **     | ** ** | ** **  | ** ** | **Accumulated**   | ** ** | ** **          | ** ** | **retained earnings** | ** ** | **Noncontrolling** | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                                               | ** ** | **Common Stock**                     | ** ** | **Additional** | ** ** | **Other**   | ** ** | ** **        | ** ** | **related to** | ** ** | **interest in**       | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                                                                               | ** ** | ** **                                | ** ** | **Par**        | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated**     | ** ** | **noncontrolling**         | ** ** | **consolidated**   | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                               | ** ** | **Shares**                                | ** ** | **Value**      | ** ** | **Capital** | ** ** | **Loss**          | ** ** | **Deficit**         | ** ** | **interests**              | ** ** | **equity**         | ** ** | **Total**  | ** ** | **Loss**          | ** ** |
| ** **                                                                               |       | **(In  thousands)**                       |       |
| **Balance  - January 1, 2010**                                                      |       | 6,455                                     |       | $              | 6          |        | $          | 866,557           |       | $                   | (87)       |                       | $          | (877,155)          |       | $          | —     |              | $          | 17,539 |   | $      | 6,860   |   | $      | (3,300) |   |
| Cumulative effect  adjustment from the adoption of the amendments to ASC Topic 810  |       |                                      |       |           |       |        |       |              |       |                |       | 244,865                    |       |               |       | 244,865    |       |              |       |
| Net income (loss)                                                                        |       |                                      |       |           |       |        |       |              |       | (137)               |       | (3,844)                    |       | 681                |       | (3,300)    |       |              |       |
| Distributions of  Consolidated Investment Products noncontrolling interest               |       |                                      |       |           |       |        |       |              |       |                |       | (5,566)                    |       |               |       | (5,566)    |       |              |       |
| Withdrawals of  DPLC noncontrolling interest                                             |       |                                      |       |           |       |        |       |              |       |                |       |                       |       | (9,145)            |       | (9,145)    |       |              |       |
| Previously  designated derivatives - amortization of net loss                            |       |                                      |       |           |       |        |       | 24                |       |                |       |                       |       |               |       | 24         |       | 24                |       |
| Foreign currency  translation loss                                                       |       |                                      |       |           |       |        |       | (47)              |       |                |       |                       |       |               |       | (47)       |       | (47)              |       |
| Issuance of stock  warrants                                                              |       |                                      |       |           |       | 529         |       |              |       |                |       |                       |       |               |       | 529        |       |              |       |
| Share-based  compensation                                                                |       |                                      |       |           |       | 9           |       |              |       |                |       |                       |       |               |       | 9          |       |              |       |
| **Balance  - March 31, 2010**                                                       |       | 6,455                                     |       | $              | 6          |        | $          | 867,095           |       | $                   | (110)      |                       | $          | (877,292)          |       | $          | 235,455    |              | $          | 9,075  |   | $      | 234,229 |   | $      | (3,323) |   |

 

See notes to condensed consolidated financial statements.

 

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**DEERFIELDCAPITAL CORP. AND ITS SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

 
| ** **                                                                                                                                      | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                      | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                                                                                                                      | ** ** | **(In thousands)**                    | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                                                                      |       |                                  |       |   |   |
| Net income  (loss) attributable to common stockholders                                                                                          |       | $                                     | (3,300)    |   | $ | 11,539 |   |
| **Adjustments  to reconcile net income (loss) attributable to common stockholders****to  net cash (used in) provided by operating activities:** |       |                                  |       |   |   |
| Net premium and  discount amortization on investments, loans and debt issuance costs                                                            |       | 1,708                                 |       | (59) |   |
| Share-based  compensation                                                                                                                       |       | 9                                     |       | 41 |   |
| Issuance of  stock warrants                                                                                                                     |       | 528                                   |       | — |   |
| Net purchases of  investments at fair value                                                                                                     |       | (16,543)                              |       | (582) |   |
| Net gain from  investments at fair value                                                                                                        |       | (73,032)                              |       | (5,138) |   |
| Net loss on  liabilties at fair value                                                                                                           |       | 87,855                                |       | — |   |
| Other-than-temporary  impairment on available-for-sale securities                                                                               |       | —                                |       | 31 |   |
| Net gain on  other investments                                                                                                                  |       | (2)                                   |       | — |   |
| Net sales of  loans held for sale                                                                                                               |       | 24                                    |       | 967 |   |
| Net gain on  loans                                                                                                                              |       | (2,754)                               |       | (5,815) |   |
| Provision for  loan losses                                                                                                                      |       | 4,186                                 |       | 2,107 |   |
| Net changes in  undesignated derivatives                                                                                                        |       | 447                                   |       | 137 |   |
| Amortization of  net loss on previously designated derivatives                                                                                  |       | 24                                    |       | 49 |   |
| Depreciation and  amortization                                                                                                                  |       | 5,738                                 |       | 1,635 |   |
| Impairment of  intangible assets                                                                                                                |       | 168                                   |       | — |   |
| Non-cash rental  expense                                                                                                                        |       | (89)                                  |       | 141 |   |
| Provision for  income taxes                                                                                                                     |       | —                                |       | 18 |   |
| **Changes  in operating assets and liabilities:**                                                                                               |       |                                  |       |   |   |
| Due from broker                                                                                                                                 |       | 18,345                                |       | 1,921 |   |
| Interest receivable                                                                                                                             |       | (1,988)                               |       | 530 |   |
| Other receivable                                                                                                                                |       | (27,752)                              |       | 3,513 |   |
| Prepaid and  other assets                                                                                                                       |       | (1,448)                               |       | (200) |   |
| Accrued interest  on repurchase agreements                                                                                                      |       | (8)                                   |       | (354) |   |
| Due to broker                                                                                                                                   |       | 41,731                                |       | (1,253) |   |
| Interest payable                                                                                                                                |       | 173                                   |       | (4,030) |   |
| Accrued and  other liabilities                                                                                                                  |       | (1,605)                               |       | (8,076) |   |
| **Net  cash (used in) provided by operating activities**                                                                                        |       | 32,415                                |       | (2,878) |   |
|                                                                                                                                            |       |                                  |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                                      |       |                                  |       |   |   |
| Change in  restricted cash and cash equivalents                                                                                                 |       | (53,289)                              |       | 52,987 |   |
| Proceeds from  the sale of investments at fair value previously classified as  available-for-sale                                               |       | 58,717                                |       | — |   |
| Principal  payments on investments at fair value previously classified as  available-for-sale                                                   |       | 11,099                                |       | 14,423 |   |
| Origination and  purchase of loans held for investment                                                                                          |       | (37,009)                              |       | (67,978) |   |
| Principal payments  on loans held for investment                                                                                                |       | 20,501                                |       | 10,021 |   |
| Proceeds from  sale of loans held for investment                                                                                                |       | 15,019                                |       | 10,956 |   |
| Principal  payments on loans held for sale previously classified as held for investment                                                         |       | 3,743                                 |       | — |   |
| Proceeds from  sale of loans held for sale previously classified as held for investment                                                         |       | —                                |       | 1,165 |   |
| Purchases of  fixed assets                                                                                                                      |       | (320)                                 |       | — |   |
| **Net  cash provided by investing activities**                                                                                                  |       | 18,461                                |       | 21,574 |   |
|                                                                                                                                            |       |                                  |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                                      |       |                                  |       |   |   |
| Net payments  under repurchase agreements                                                                                                       |       | (13,832)                              |       | (7,117) |   |
| Payments made on  Wachovia Facility                                                                                                             |       | —                                |       | (1,932) |   |
| Payments made on  long term debt                                                                                                                |       | (43,603)                              |       | — |   |
| Payment of debt  issuance costs                                                                                                                 |       | (250)                                 |       | (83) |   |
| Distributions  from noncontrolling interest                                                                                                     |       | (5,566)                               |       | — |   |
| **Net  cash used in financing activities**                                                                                                      |       | (63,251)                              |       | (9,132) |   |
|                                                                                                                                            |       |                                  |       |   |   |
| Foreign currency  translation                                                                                                                   |       | (47)                                  |       | (1) |   |
| Net increase  (decrease) in cash and cash equivalents                                                                                           |       | (12,422)                              |       | 9,563 |   |
| Cash and cash  equivalents at beginning of year                                                                                                 |       | 48,711                                |       | 32,791 |   |
| **Cash  and cash equivalents at end of year**                                                                                                   |       | $                                     | 36,289     |   | $ | 42,354 |   |
|                                                                                                                                            |       |                                  |       |   |   |
| **SUPPLEMENTAL  DISCLOSURE:**                                                                                                                   |       |                                  |       |   |   |
| Cash paid for  interest                                                                                                                         |       | $                                     | 7,124      |   | $ | 10,412 |   |
| Cash (received)  paid for income taxes                                                                                                          |       | 8                                     |       | (175) |   |

 

See notes to condensed consolidated financial statements.

 

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**DEERFIELDCAPITAL CORP. AND ITS SUBSIDIARIES**

** **

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**1. ORGANIZATION**

 

DeerfieldCapital Corp., a Maryland corporation, (“DFR” and, together with itssubsidiaries, “us,” “we” or “our,”), through its wholly-owned subsidiary,Deerfield Capital Management LLC (“DCM”), manages client assets, including bankloans and other corporate debt, residential mortgage-backed securities, (“RMBS”),government securities and asset-backed securities (“ABS”). In addition, we havea Principal Investing segment with an investment portfolio comprised of fixedincome investments, including bank loans and other corporate debt and RMBS.

 

***Business Segments***

 

Ourbusiness consists of three business segments:

 

*Investment Management*— We manage assets within avariety of investment vehicles, including collateralized debt obligations (“CDOs”),separately managed accounts and other investment vehicles and earn investmentadvisory fees for providing our services. We specialize in managing fixedincome investments, including corporate debt, RMBS, government securities andABS.

 

*Principal Investing*—We have a portfolio ofinvestments comprised primarily of fixed income investments, including bankloans and other corporate debt and RMBS. Income from this business segment isinfluenced by four factors: (i) the nominal amount of interest income weearn on our investment portfolio and the net spread, or difference, between theinterest income we earn on our investment portfolio and the cost of ourborrowings net of hedges, if any, (ii) the net recognized gains andlosses, if any, on our investment portfolio, (iii) provision for loanlosses, if any, and (iv) the volume or aggregate amount of suchinvestments. Investments in senior secured loans (first lien and second lienterm loans), senior subordinated debt facilities and other junior securities,typically across a range of industries, are referred to as “Corporate Loans.”We consolidated Deerfield Pegasus Loan Capital LP (“DPLC”), DPLC General PartnerLLC (“DPLC GP”) and DFR Middle Market CLO Ltd. (“DFR MM CLO”) into thePrincipal Investing segment.

 

*Consolidated Investment Products—*We provideinvestment management services to seven CDOs (the “CIP CDOs”) that, effective January 1,2010, we are required to consolidate as Variable Interest Entities (“VIEs”) inaccordance with consolidation guidance in the Financial Accounting StandardsBoard (“FASB”) Accounting Standards Codification (“Codification”) Topic 810—*Consolidation* (“ASC Topic 810”), asamended by Accounting Standards Update (“ASU”) 2009-17 (“ASU 2009-17”).  We earn contractually-negotiated managementfees for providing services to these CDOs. Management fees vary by contract andperformance, but may include senior fees, subordinated fees and incentivefees.  The Consolidated InvestmentsProducts segment was established on January 1, 2010, and we elected thefair value option for all assets and liabilities of the CIP CDOs.  The Consolidated Investment Products segmentexcludes DFR MM CLO which is included in the Principal Investing segmentbecause we own 100% of its preference shares.

 

**2. ACCOUNTING POLICIES AND RECENT ACCOUNTING UPDATES**

 

*Basis of Presentation*—The accompanying unauditedcondensed consolidated financial statements have been prepared by us inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) forinterim financial information and are in the form prescribed by the Securitiesand Exchange Commission (the “SEC”) pursuant to Regulation S-X and theinstructions to Form 10-Q. Accordingly, we do not include all of theinformation and footnotes for complete financial statements as required byGAAP. The interim unaudited condensed consolidated financial statements shouldbe read in conjunction with our audited financial statements as of and for theyear ended December 31, 2009, which are included in our Annual Report on Form 10-Kfiled with the SEC on March 23, 2010 (the “2009 10-K”). In the opinion ofour management, all adjustments, consisting of only normal recurring accruals,necessary for a fair presentation of our financial position, results ofoperations and cash flows have been included. The nature of our business issuch that the results of any interim period information are not necessarilyindicative of results for a full year.

 

*Principles of Consolidation*—The condensed consolidatedfinancial statements include the financial statements of DFR and our subsidiarieswhich are (i) wholly-owned subsidiaries, (ii) subsidiaries in whichDFR has a controlling interest under the consolidation guidance in ASC Topic810 and (iii) entities that are VIEs with respect to which we are theprimary beneficiary under ASC Topic 810. Under ASC Topic 810, a company is theprimary beneficiary of a VIE if it has a controlling financial interest in theVIE.  A company is deemed to have acontrolling financial interest in a VIE if it has both 

 

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(i) the power to directthe activities of the VIE that most significantly impact the VIE’s economicperformance and (ii) the obligation to absorb the losses of the VIE thatcould potentially be significant to the VIE or the right to receive benefitsfrom the VIE that could potentially be significant to the VIE. All intercompanybalances and transactions have been eliminated in consolidation.

 

Forthe three months ended March 31, 2010, we consolidated DPLC as a result ofour controlling interest therein pursuant to the consolidation guidance in ASCTopic 810. We also consolidated DPLC GP, the general partner of DPLC, throughwhich we made our investment in DPLC. We had a controlling financial interestin DPLC and DPLC GP as a result of owning more than 50% of the outstandingvoting interests in DPLC GP. On April 15, 2010, we withdrew theentire portion of our capital account attributable to our investment in DPLCGP.  See Notes 3 and 13 for detailsrelated to the warrants we issued in connection with the formation of DPLC andfor details related to the warrants granted in connection with therestructuring of DPLC. The net loss attributable to DFR in our consolidatedstatements of operations excludes the net loss attributable to ournoncontrolling interest in DPLC. We consolidated assets of $22.4 millionand liabilities of $13.4 million related to DPLC as of March 31,2010.

 

*Variable Interest Entities*—ASC Topic 810 generallyrequires that the assets, liabilities and results of operations of a VIE beconsolidated into the financial statements of the enterprise that has acontrolling financial interest in the VIE. The interpretation provides aframework for determining whether an entity should be considered a VIE andevaluated for consolidation. We consider all parties to the transaction todetermine whether the entity is a VIE and, if so, whether our involvement withthe entity results in a variable interest in the entity. If we determine thatwe do have a variable interest in the entity, we perform an analysis todetermine whether we are the primary beneficiary. If we determine that we arethe primary beneficiary, we consolidate the VIE into the consolidated financialstatements as required. See Note 4 for our analysis of entities with respect towhich we have determined that we have a variable interest, including ourdetermination of whether we are the primary beneficiary.

 

Asof March 31, 2010, we consolidated DFR MM CLO, as we determined that weare to be the primary beneficiary of this VIE. Although we consolidate 100% ofthe assets and liabilities of DFR MM CLO, our maximum exposure to loss on ourinvestment in this entity is limited to our initial investment of$69.0 million. The debt holders of DFR MM CLO have recourse only to theassets of the CLO and not to our general assets. The economic impact of ourinvestment in DFR MM CLO is determined by the cash flows distributed to us byDFR MM CLO on our investment in $50.0 million of preference shares and$19.0 million of debt of DFR MM CLO. Our preference shares are subject todiversion of cash flows as provided in accordance with the indenture for DFR MMCLO. For the three months ended March 31, 2010, the net income of $3.2million recorded under GAAP for DFR MM CLO was not indicative of the cash flowdistributions from DFR MM CLO of $3.8 million through March 31, 2010. Thecash distribution of $3.8 million included $3.6 million related to ourinvestment in the preference shares of DFR MM CLO and $0.2 million in intereston our investment in DFR MM CLO debt. We have also received a cash distributionrelated to our investment in the preference shares of DFR MM CLO of $3.9million in the second quarter of 2010. While we expect to receive future cashflows from this investment, it is very difficult to predict the timing andamount of such future cash flows. We consolidated assets of $282.3 millionand liabilities of $217.7 million related to DFR MM CLO as of March 31,2010.  DFR MM CLO is consolidated intoour Principal Investing segment because we own 100% of its preference shares.

 

Wehave a variable interest in each of the CDOs we manage due to the provisions oftheir various management agreements. As of March 31, 2010, we had certaindirect investments in the CDOs which represent a small portion of the totaldebt and equity issued by the CDOs. Effective January 1, 2010, weconsolidated the CIP CDOs within our Consolidated Investment Products segmentbecause we determined that we are to be the primary beneficiary of these CDOs.Although our relationship with the CIP CDOs has not changed, we are required toconsolidate the CIP CDOs as a result of the adoption of the amendments to ASCTopic 810.  There have been no changes to the terms of our managementcontracts with the CIP CDOs, the revenues we are contractually entitled toreceive from the CIP CDOs or our exposure to liability with respect to the CIPCDOs.  DFR MM CLO is not includedin the Consolidated Investment Products segment but is included in thePrincipal Investing segment because we own 100% of its preference shares.Although we consolidate 100% of the assets, liabilities and equity of the CIPCDOs, our maximum exposure to loss related to the Consolidated InvestmentProducts is limited to $2.3 million consisting of $0.9 million of preferenceshares and $1.4 million of CDO debt that we own and our management fees whichare earned over the life of the CIP CDOs. The debt holders of the CIP CDOs have recourse only to the assets of therespective CDO and not to our general assets. For the three months ended March 31, 2010, the net loss of $3.8million recorded under GAAP for the Consolidated Investment Products segmentwas not indicative of the cash flow distributions from the CIP CDOs of $3.6million.  For the three months ended March 31,2010, we received distributions from the CIP CDOs of $3.5 million and $0.1million relating to management fees and interest on our debt holdings,respectively. We consolidated assets of $2.4 billion and liabilities and equityof $2.1 billion related to the Consolidated Investment Products 

 

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segment as of March 31,2010 despite the fact that the assets of the CIP CDOs are not available to us,nor are we obligated for the debt. We generally invest in only a relativelysmall portion of the unrated, junior subordinated tranches of the CDOs that wemanage. These investments can take the form of subordinated notes or preferenceshares.  We have determined that, although the junior tranches havecertain characteristics of equity, they should be recorded as debt on ourbalance sheet, as the subordinated notes have a stated maturity indicating adate on which they are mandatorily redeemable.  The preference shares arealso classified as debt, as redemption is required only upon liquidation ortermination of the CLO and not upon our liquidation or termination.

 

Asof March 31, 2010, we have a variable interest in 20 CDOs that are notconsolidated as part of the Consolidated Investment Products segment as we havedetermined we are not the primary beneficiary of these VIEs. Our maximum lossexposure associated with nonconsolidated CDOs is limited to any management feesassociated with the CDOs. As of March 31, 2010, we have recordedmanagement fee receivables of $0.9 million collectively from the unconsolidatedCDOs. See Note 4 for additional discussion of the Consolidated InvestmentProducts.

 

*Significant Accounting Policies*— Oursignificant accounting policies are discussed in the Notes to the ConsolidatedFinancial Statements included in our 2009 10-K.

 

***Recent Accounting Updates***

 

InJune 2009, the FASB issued SFAS No. 167, *Amendments to FASB Interpretation No. 46(R) *(“SFASNo. 167”). In December 2009, the FASB issued ASU 2009-17 to revisethe Codification to include SFAS No. 167 within ASC Topic 810. In February 2010,the FASB issued ASU 2010-10, *Amendments forCertain Investment Funds*(“ASU2010-10”), to defer the effective date of the amendments to theconsolidation requirements of ASC Topic 810 resulting from the issuance of ASU2009-17 for reporting entities with interests in entities with all theattributes of an investment company but specifically excluding interests insecuritization entities.  This statementwas issued to address concerns about financial statement preparers’ ability tostructure transactions to avoid consolidation, balanced with the need for morerelevant, timely and reliable information about an entity’s involvement in aVIE. This statement requires an enterprise to perform an analysis to determinewhether the enterprise’s variable interest or interests give it a controllingfinancial interest in a VIE. This analysis identifies the primary beneficiaryof a VIE as the enterprise that has both the power to direct the activities ofa VIE that most significantly impact the entity’s economic performance and theobligation to absorb losses of the entity that could potentially be significantto the VIE or the right to receive benefits from the entity that couldpotentially be significant to the VIE. Additionally, an enterprise is requiredto assess whether it has an implicit financial responsibility to ensure that aVIE operates as designed when determining whether it has the power to directthe activities of the VIE that most significantly impact the entity’s economicperformance. The amendments to ASC Topic 810 also amend FIN 46(R) toeliminate the quantitative approach to determining the primary beneficiary of aVIE and require ongoing reassessments of VIE status.  We adopted the amendments to ASC Topic 810 onJanuary 1, 2010. See further disclosure related to the Consolidated InvestmentProducts in Note 4.

 

InJanuary 2010, the FASB issued ASU No. 2010-06—*Fair Value Measurements and Disclosure (“ASC Topic820”)—Improving Disclosures about Fair Value Measurements* (“ASU2010-06”). ASU 2010-06 amends ASC Topic 820 to add new requirements fordisclosures about transfers into and out of Levels 1 and 2 and separatedisclosures about purchases, sales, issuances and settlements relating toLevel 3 measurements. ASU 2010-06 also clarifies existing fair valuedisclosures about the level of disaggregation and about inputs and valuationtechniques used to measure fair value. We adopted ASU 2010-06 and have includedthe required disclosures in Note 5, with the exception of the requirementto provide disclosure of the Level 3 activity of purchases, sales,issuances and settlements on a gross basis, which will be effective for ourinterim and annual reporting periods that begin after December 15, 2010.

 

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**3. PROPOSED STRATEGICTRANSACTIONS**

 

***The Acquisition andIssuance of the Acquisition Shares***

 

On March 22, 2010,we entered into an Acquisition and Investment Agreement (the “Acquisition Agreement”) with BountyInvestments, LLC (“Bounty”) and Columbus Nova Credit Investments Management,LLC (“CNCIM”), pursuant to which we agreed to acquire all of the outstandingequity interests of CNCIM from Bounty (the “Acquisition”) for a total purchase price of $32.5 millionconsisting of (i) the issuance of 4,545,455 shares (at an impliedprice of $5.50 per share) (the “AcquisitionShares”) of our common stock,par value $0.001 per share (the “Common Stock”) and (ii) deferred paymentstotaling $7.5 million in cash payable in five equal annual installmentsbeginning six months after the closing date of the Acquisition and the issuanceof the Convertible Notes (the “ClosingDate”).  The final purchase price foraccounting purposes will be determined at the Closing Date which is contingentupon shareholders approval of the issuance of the Acquisition Shares and the ConversionShares (as defined below).

 

Wehave agreed to pay the cost of transferring the operations of CNCIM asestimated on the Closing Date, which are currently anticipated to beapproximately $1.2 million. Bounty has agreed to pay the costs in excessof such amount. Bounty has also agreed to indemnify us for losses relating toCNCIM’s operating liabilities arising prior to the Closing Date (other thanliabilities under certain employment agreements, liabilities relating to theCNCIM CLOs’ management agreements, liabilities relating to actions takenpursuant to a Transition Services Agreement with Bounty and CNCIM, pursuant towhich we are providing services to CNCIM in connection with CNCIM’s managementof the CNCIM CLOs (“Transition Services Agreement”) and the expenses of thetransfer of operations) for one year from the Closing Date, as well as certainpre-closing tax liabilities for three years from the Closing Date, up to$5.0 million in the aggregate.

 

TheAcquisition Agreement contains customary covenants of CNCIM and us, includingwith respect to the operation of their respective businesses between the dateof the Acquisition Agreement and the Closing Date. The consummation of thetransactions contemplated by the Acquisition Agreement (the “Closing”) is subject to severalclosing conditions, including, among other things, the approval by ourstockholders of the issuance of the Acquisition Shares and the potentialissuance of the Conversion Shares (as defined below), collectively referred toas the “Stock Issuances,” the consummation of the Senior Notes Discharge (asdefined below), the absence of certain governmental constraints and the absenceof a material adverse effect on our business of that of CNCIM.

 

***The Convertible Notes Agreement and Potential Issuance ofthe Conversion Shares***

 

On March 22, 2010, in connection with enteringinto the Acquisition Agreement, we entered into a Senior SubordinatedConvertible Notes Agreement (the “ConvertibleNotes Agreement”) with Bounty pursuant to which Bounty has agreed topurchase for cash $25.0 million in aggregate principal amount of oursenior subordinated convertible notes (the “Convertible Notes”), convertible into 4,132,231 shares ofCommon Stock (as such amount may be adjusted in certain events or increased inconnection with the payment of interest-in-kind (“PIK Interest”)) (the”Conversion Shares”) at an initialconversion price of $6.05 per share, subject to adjustment.

 

We may issue and sell up to an additional$25.0 million of Convertible Notes under the Convertible Notes Agreement,subject to Bounty’s approval, although we have no agreement with respect to anysuch additional issuances at this time. The holders of Convertible Notes willhave the right, at any time, to convert the principal amount of the ConvertibleNotes held by such holders into Conversion Shares at the conversion rate, whichwill initially be approximately 165.29 shares per $1,000 principal amountof Convertible Notes (the “ConversionRate”) (equal to a conversion price of $6.05 per share), and is subjectto adjustment from time to time for specified events.

 

Weintend to close the issuance and sale of the Convertible Notes to Bountysimultaneously with the closing of the Acquisition on the Closing Date. AllConvertible Notes issued on the Closing Date or thereafter will mature on thedate that is seven years and six months following the Closing Date. Interest onthe Convertible Notes will be payable to the holders of the Convertible Notesquarterly in arrears on each January 1, April 1, July 1 and October 1.We will pay interest in cash at a per annum rate starting at 8% and increasingto 11% depending on the interest period in which interest is due and payable;provided, that we may, in our sole discretion and upon notice to the holders ofthe Convertible Notes, elect to pay up to 50% of the interest payment due toany holder of the Convertible Notes in PIK Interest subject to certainconditions.

 

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***The Senior Notes Discharge***

 

On March 22, 2010, DFR and Deerfield entered intoa Payment Agreement and Release (the “SeniorNotes Discharge Agreement”) with the holders of the Series A SeniorSecured Notes issued by Deerfield (the “Series ANotes”) and the holders of the Series B Senior Secured Notes issuedby Deerfield (the “Series B Notes”and, together with the Series A Notes, the “Senior Notes”), pursuant to which we have agreed with theholders of the Senior Notes to discharge all of the approximately$48.8 million in aggregate principal amount of Series A Notesoutstanding at approximately 64.1% of the principal amount thereof plus accruedinterest, and all of the approximately $25.1 million in aggregateprincipal amount of the Series B Notes outstanding at approximately 94.5%of the principal amount thereof plus accrued interest, or an aggregate discountof approximately 25.6% from the face amount of the Senior Notes plus accruedinterest (the “Senior Notes Discharge”).We are required to consummate the Senior Notes Discharge if we complete one ormore debt or equity financing transactions or recapitalization transactions (orany combination of debt or equity financing and recapitalization transactions),which result in cash proceeds to DFR or Deerfield in an aggregate amount of atleast $25 million on or prior to July 31, 2010. The issuance of theConvertible Notes would trigger this requirement. We intend to use the proceedsof the issuance of the Convertible Notes, together with other available funds,to effect the Senior Notes Discharge. Upon consummation of the Senior NotesDischarge, all obligations and liabilities of DFR and Deerfield under theSenior Notes will be released and the intercreditor agreement related to theSenior Notes will be terminated.

 

Effective upon the date of the Senior Notes DischargeAgreement, we released certain of the holders of the Senior Notes from theirobligation to indemnify us for losses related to certain matters pursuant tothe terms of the Merger Agreement (which indemnification obligations wouldotherwise have remained in effect until June 30, 2010).

 

***The DPLC Restructuring***

 

We announced on March 22, 2010 that we enteredinto a Termination Agreement (the “TerminationAgreement”) with Pegasus Deerfield (AIV), LLC, (“Pegasus Deerfield”), PGSManagement, LLC, (“PM”,and together with Pegasus Deerfield, the “Pegasus Parties”), DPLC, DCM, DPLC GP, Deerfield Loan Manager LLC (“DLM” and together with DFR, DCM andDLM, the “Deerfield Parties”)and Jonathan Trutter, pursuant to which (i) the Pegasus Parties waivedcertain rights with respect to the Stock Issuances and (ii) the DeerfieldParties and the Pegasus Parties terminated or amended certain provisions ofagreements related to DPLC and cancelled warrants to purchase three millionshares of our Common Stock, which is all of the warrants previously issued tothe Pegasus Parties (the “DPLCRestructuring”). Pursuant to the Termination Agreement, DPLC GP andDPLC released all partners of DPLC from their unfunded capital commitments toDPLC as of the date of the Termination Agreement. In addition, DPLC madedistributions of $9.0 million to the Pegasus Deerfield and an amount equalto his entire capital account balance to Jonathan Trutter. DPLC GP alsowithdrew an amount equal to the entire portion of its capital accountattributable to DLM’s investment in DPLC GP and distributed such amount toDLM, our wholly-owned subsidiary. Additionally, we granted Pegasus Deerfieldand certain of its associates warrants to purchase an aggregate of250,000 shares of common stock at an exercise price of $4.25 per share (“DPLCRestructuring Warrants”).  See Note 13for more details on the DPLC Restructuring Warrants. Pegasus Deerfield has alsonotified us that they intend to withdraw their entire remaining capital accountbalance.

 

**4. CONSOLIDATED INVESTMENT PRODUCTS**

 

Weearn contractually-negotiated management fees for providing investmentmanagement services to CDOs for which we have determined we have a variableinterest. Management fees vary by contract and performance of the products, butmay include senior fees, subordinated fees and incentive fees. The adoption ofthe amendments to ASC Topic 810 requires an enterprise perform an analysis todetermine whether the enterprise’s variable interest or interests give it acontrolling financial interest in a VIE. This analysis identifies the primarybeneficiary of a VIE as the enterprise that has both the power to direct theactivities of a VIE that most significantly impact the entity’s economicperformance and the obligation to absorb losses of the entity that couldpotentially be significant to the VIE or the right to receive benefits from theentity that could potentially be significant to the VIE. Additionally, anenterprise is required to assess whether it has an implicit financialresponsibility to ensure that a VIE operates as designed when determiningwhether it has the power to direct the activities of the VIE that mostsignificantly impacts the entity’s economic performance.

 

As part of this analysis,we use a quantitative model to corroborate the qualitative assessments. Thequantitative model includes an analysis of the expected performance of the CDOsand a comparison of our absorption of this performance relative to the otherinvestors in the CDOs. We have determined that we could receive significantbenefits and/or absorb significant losses from certain CDOs in which we hold afirst loss position and have the right to significant fees. It was determinedthat our benefits and losses from certain other CDOs could not be significant,particularly in situations where we do not hold a first loss position and wherethe fee interests are based upon a fixed percentage of collateral asset value.

 

BeginningJanuary 1, 2010, we are required to consolidate the CIP CDOs creating theConsolidated Investment Products segment. DFR MM CLO is not included in the ConsolidatedInvestment Products segment but is included in the Principal Investing segmentbecause we own 100% of its preference shares. As a result, we have consolidatednon-recourse assets of $2.4 billion and non-recourse liabilities of $2.1billion into our condensed consolidated financial statements as of March 31,2010.

 

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The collateral assets ofthe CIP CDOs are held solely to satisfy the obligations of the CIP CDOs. Wehave no right to the benefits from, nor do we bear the risks associated with,the collateral assets held by the CIP CDOs beyond our minimal directinvestments in, and management fees generated from the CIP CDOs. If we were toliquidate, the collateral assets would not be available to the generalcreditors of DFR, and as a result, we do not consider them to be our assets.Additionally, the investors in the CIP CDOs have no recourse to our general creditfor the debt issued by the CIP CDOs. We therefore do not consider this debt tobe an obligation of ours.

 

Wehave included other required disclosures related to the Consolidated InvestmentProducts segment in Notes 2, 5, 8, 12 and 17.

 

**5. FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The following is adescription of the valuation methodologies used for instruments measured atfair value, including the general classification of such instruments pursuantto the valuation hierarchy described below, based on their classification inthe consolidated balance sheet. Management, from time to time, may makeadjustments to valuation methodologies described below under certain marketconditions. Management maintains a consistent policy and process foridentifying when and how such adjustments should be made. To the extent that asignificant fair value adjustment is made by management, the valuationclassification would generally be considered a Level 3 within the fairvalue hierarchy.

 

***Investments at Fair Value***

 

Investments at fair valueinclude RMBS, loans and other investments held in DPLC, preferred shares ofCDOs, beneficial interests in CDOs and contingent liabilities related to CDOs.The fair value for RMBS generally represents a modeled valuation, whichincludes spreads and prepayment rates which are observable in the market.Agency RMBS are classified as Level 2 within the fair value hierarchy. Thecontinuing illiquidity in the non-Agency RMBS markets has limited theavailability of market data which is included in the valuation models.Non-Agency RMBS are valued using model pricing that management believes wouldbe used by market participants and classified as Level 3 within the fairvalue hierarchy given this limited availability of observable market data. Loansand other investments in DPLC are generally priced at a composite of themid-point in the bid-ask spread of dealer quotes or based on the compositeprice of a different tranche of the same security if dealer quotes areunavailable for the specific tranche we own. Loans or other investments in DPLCpriced in this manner are classified as Level 2 within the fair valuehierarchy. Where no such quotes are available, the price may be based on aninternally developed model using composite or other comparable market datawhich could include unobservable market inputs. Loans and other investmentsheld in DPLC priced in this manner are classified as Level 3 within thefair value hierarchy.

 

The preferred shares ofCDOs are valued by management by considering, among other things, availablebroker quotes. If a broker quote is unavailable, the preferred shares of CDOsare valued using composite or other comparable market data management believeswould be used by market participants. Preferred shares of CDOs are classified asLevel 3 within the fair value hierarchy. Beneficial interests in CDOs andcontingent liabilities related to CDOs are valued by management via internalmodels and as such are also classified as Level 3 within the fair valuehierarchy.

 

***Derivative assets and liabilities***

 

The derivatives held byus generally represent instruments traded in the over-the-counter market andare valued using internally-developed market-standard models. The inputs to thevaluation models for the interest rate swaps and caps represent observablemarket data available at commonly quoted intervals for the full terms of thecontracts. All interest rate derivatives are classified as Level 2 withinthe fair value hierarchy. The significant inputs to the valuation models forwarrants may contain a significant level of unobservable inputs and areclassified as Level 3 within the fair value hierarchy.

 

***Loans held for sale***

 

Loans held for sale arecarried at the lower of cost or fair value. If the fair value of a loan is lessthan its cost basis, a valuation adjustment is recognized in the consolidatedstatements of operations, and the loan’s carrying value is adjustedaccordingly. The valuation adjustment may be recovered if the fair valueincreases, which is also recognized in the consolidated financial statements.Loans held for sale are generally priced at a composite of the mid-point in thebid-ask spread of dealer quotes or based on the composite price of a differenttranche of the same security if dealer quotes are unavailable for the specifictranche we own. As of March 31, 2010, we classify loans held for salepriced in this manner as Level 2 within the fair value hierarchy. Where nosuch quotes are available, price may be based on an internally developed modelusing composite or other comparable market data which could includeunobservablemarket inputs. Loans held for sale priced in this manner are classifiedas Level 3 within the fair value hierarchy.

 

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***Long Term Debt held in ConsolidatedInvestment Products***

 

Long term debt held inConsolidated Investment Products includes all of the debt, junior subordinatedtranches and preference shares of the CIP CDOs. The fair value for Long-term debt held in Consolidated InvestmentProducts generally represents a modeled valuation that utilizes inputs that areboth observable and unobservable in the market. The preferred shares of CDOs within the long term debt held inConsolidated Investment Products are valued by management by considering, amongother things, available broker quotes. If a broker quote is unavailable, thepreferred shares of CDOs are valued using internally developed models that utilizecomposite or other comparable market data management believes would be used bymarket participants, which include unobservable market inputs primarily as aresult of the illiquidity. All of the long term debt held in ConsolidatedInvestment Products are classified as Level 3 within the fair valuehierarchy.

 

Wepreviously elected the fair value option for investments held in DPLC to alignthe accounting basis used to consolidate those investments into DFR with theaccounting basis of those investments presented in DPLC’s financial andinvestor reporting, where they are valued at fair value. As of March 31,2010, the difference between the aggregate estimated fair value of loans heldin DPLC of $5.3 million and the outstanding principal balance of loans heldin DPLC of $5.6 million was $0.3 million. As of March 31, 2010,there were no loans held in DPLC that were 90 days or more past due oninterest payments or on nonaccrual status. Interest income on loans held inDPLC is recorded in interest income on the condensed consolidated statements ofoperations and represents the current period interest accrual. ASC Topic 825requires an estimate of the gains and losses included in earnings during theperiod that are attributable to changes in instrument-specific credit risk. Forfloating rate loans, all changes in estimated fair value are attributed toinstrument-specific credit risk. For fixed rate instruments, an allocation ofthe changes in value for the period is made between those changes in estimatedfair value that are interest rate related and changes that are credit riskrelated. As of and for the three months ended March 31, 2010, all loansheld in DPLC and recorded at fair value were floating rate loans, and the netgains included in net gain on investments at fair value attributed toinstrument specific credit risk on those loans were $0.4 million.

 

We have recorded all assetsand liabilities in our Consolidated Investments Products segment at fair value.DFR MM CLO is not included in the Consolidated Investment Products segment butis included in the Principal Investing segment because we own 100% of itspreference shares. We have not elected the fair value option for DFR MM CLO,and as such, the assets and liabilities of DFR MM CLO are not recorded at fairvalue. The amendments to ASC Topic 810 indicate that assets and liabilities ofconsolidated VIEs should be recorded at their carrying value as of the datethat we became the primary beneficiary of the VIEs, provided such applicationis practicable.  We have determined it isnot practicable to initially record the CIP CDOs at their carrying value asthey have never previously been required to satisfy GAAP or other reportingrequirements.  In connection with theadoption of the amendments to ASC Topic 810, we have elected and applied the fair value optionunder ASC Topic 825—*Financial Instruments*(“ASCTopic 825”) to measure, on an entity-by-entity basis, all of the eligibleassets and liabilities of the CIP CDOs at fair value subsequent to the date ofinitial adoption of the amendments to ASC Topic 810, as we have also determinedthat measurement of the notes issued by the CIP CDOs at fair value bettercorrelates with the fair value of the assets held by the CIP CDOs, which areheld to provide the cash flows for the note obligations of the CIP CDOs.

 

EffectiveJanuary 1, 2008, we adopted ASC Topic 820—*FairValue Measurements and Disclosures* (“ASC Topic 820”). ASC Topic 820defines fair value, establishes a framework used to measure fair value andenhances disclosure requirements for fair value measurements. In accordancewith ASC Topic 820, we have categorized our financial instruments carried atfair value, based on the priority of the valuation technique, into athree-level fair value hierarchy. The valuation hierarchy is based upon thetransparency of the inputs to the valuation of the asset or liability as of themeasurement date. A financial instrument’s categorization within the valuationhierarchy is based on the lowest level of input that is significant to the fairvalue measurement. The three levels are defined as follows:

 

*Level 1*—inputs to the valuationmethodology are quoted prices (unadjusted) for identical assets or liabilitiesin active markets.

 

Thetypes of assets included in Level 1 generally are equity securities orderivatives listed on an active exchange. We held no Level 1 securities asof March 31, 2010.

 

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*Level 2*—inputs to the valuationmethodology include quoted prices for similar assets and liabilities in activemarkets and inputs that are observable for the asset or liability, eitherdirectly or indirectly, for substantially the full term of the financialinstrument.

 

Ourassets and liabilities that are generally included in this category are AgencyRMBS (as defined below), loans classified as either investments at fair valueor loans held for sale where asset valuations are provided by independentpricing services, corporate bonds, long term debt and interest ratederivatives. Agency RMBS are backed by mortgage loans and are guaranteed as toprincipal and interest by federally chartered entities such as the FederalNational Mortgage Association (“Fannie Mae”) or the Federal Home Loan MortgageCorporation (“Freddie Mac”) and, in the case of the Government NationalMortgage Association (“Ginnie Mae”), the U.S. government. We refer to theseentities as “Agencies” and to RMBS guaranteed or issued by the Agencies as “AgencyRMBS.”

 

*Level 3*—inputs to the valuationmethodology include significant unobservable inputs to the fair valuemeasurement. This includes situations where there is little, if any, marketactivity for the asset or liability.

 

Ourassets and liabilities that are generally included in this category arenon-Agency RMBS, corporate bonds, loans classified as either investments atfair value or loans held for sale where asset valuations are not provided byindependent pricing services, warrants and long term debt. Level 3 alsoincludes loans held for investment in periods when an impairment charge istaken.

 

Ourfull valuation methodology and ASC Topic 820 accounting policy are discussed inthe notes to the Consolidated Financial Statements included in our 200910-K.  There were no significant changesin our valuation methodologies during the three months ended March 31,2010.

 

***Assets and liabilities measured at fair value on a recurring basis***

 

Thefollowing table presents the financial instruments carried at fair value on arecurring basis, by caption in the condensed consolidated balance sheet and bylevel within the ASC Topic 820 valuation hierarchy, as of March 31,2010 for our Principal Investing and Investment Management segments:

 

| ** **                              | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Carrying Value** |
|-----------------------------------------|------------|--------------------|------------|-------------|------------|-------------|------------|--------------------|
| ** **                              | ** ** | **(In thousands)** |
| Investments at  fair value:             |       |               |       |        |       |        |       |               |
| RMBS                                    |       | $                  | —     |        | $          | 300,806     |       | $                  | 2,452 |   | $ | 303,258 |
| Loans                                   |       | —             |       | 4,353       |       | 912         |       | 5,265              |
| Other                                   |       | —             |       | —      |       | 4,707       |       | 4,707              |
| Derivative  assets                      |       | —             |       | —      |       | 26          |       | 26                 |
| Total financial  instrument assets      |       | $                  | —     |        | $          | 305,159     |       | $                  | 8,097 |   | $ | 313,256 |
|                                    |       |               |       |        |       |        |       |               |
| Derivative  liabilities                 |       | $                  | —     |        | $          | 236         |       | $                  | — |   | $ | 236 |
| Accrued and  other liabilities          |       | —             |       | —      |       | 312         |       | 312                |
| Total financial  instrument liabilities |       | $                  | —     |        | $          | 236         |       | $                  | 312 |   | $ | 548 |

 

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Thefollowing table presents the financial instruments carried at fair value on arecurring basis, by caption in the condensed consolidated balance sheet and bylevel within the ASC Topic 820 valuation hierarchy, as of March 31,2010, for our Consolidated Investment Products segment.  See further disclosure related to theConsolidated Investment Products in Note 4.

 

| ** **                              | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Carrying Value** |
|-----------------------------------------|------------|--------------------|------------|-------------|------------|-------------|------------|--------------------|
| ** **                              | ** ** | **(In thousands)** |
| Investments at  fair value:             |       |               |       |        |       |        |       |               |
| Loans                                   |       | $                  | —     |        | $          | 1,967,903   |       | $                  | 23,026 |   | $ | 1,990,929 |
| Corporate bonds                         |       | —             |       | 198,392     |       | 9,774       |       | 208,166            |
| Other                                   |       | —             |       | 376         |       | 107         |       | 483                |
| Derivative  assets                      |       |               |       | —      |       | 25          |       | 25                 |
| Total financial  instrument assets      |       | $                  | —     |        | $          | 2,166,671   |       | $                  | 32,932 |   | $ | 2,199,603 |
|                                    |       |               |       |        |       |        |       |               |
| Long term debt                          |       | $                  | —     |        | $          | 1,989,231   |       | $                  | 80,163 |   | $ | 2,069,394 |
| Derivative  liabilities                 |       | —             |       | 10,472      |       | —      |       | 10,472             |
| Total financial  instrument liabilities |       | $                  | —     |        | $          | 1,999,703   |       | $                  | 80,163 |   | $ | 2,079,866 |

 

Thefollowing table presents the realized and unrealized gains (losses) oninvestments at fair value as reported in our condensed consolidated statementsof operations:

 
| ** **                 | ** ** | **For the three months ended March 31,** |
|----------------------------|------------|-----------------------------------------------|
| ** **                 | ** ** | **2010**                                      | ** ** | **2009** |
| ** **                 | ** ** | **(In thousands)**                            |
| Realized gains  (losses)   |       | $                                             | 9,725 |   | $ | 5 |
| Unrealized gains  (losses) |       | 63,307                                        |   | 5,133 |
| Total gains  (losses)      |       | $                                             | 73,032 |   | $ | 5,138 |

 

***Changes in Level 3 recurringfair value measurements***

 

Thetable below includes a rollforward of the balance sheet amounts for the threemonths ended March 31, 2010 (including the change in fair value) forfinancial instruments classified within Level 3 of the valuation hierarchyfor our Principal Investing and Investment Management segments:

 
| ** **                         | ** ** | ** **                                                         | ** ** | ** **          | ** ** | ** **               | ** ** | ** **             | ** ** | ** **                   | ** ** | **Changes  in Unrealized**  | ** ** |
|------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **Fair  Value Measurements Using Significant Unobservable Inputs** | ** ** | **Gains  (Losses)** | ** ** |
| ** **                         | ** ** | **Estimated**                                                      | ** ** | **Net  Realized/**  | ** ** | **Purchases,  (Sales),** | ** ** | **Net Transfers** | ** ** | **Estimated**                | ** ** | **Related  to Financial**   | ** ** |
| ** **                         | ** ** | **Fair  Value**                                                    | ** ** | **Unrealized**      | ** ** | **Issuances  and**       | ** ** | **In  (Out)**          | ** ** | **Fair  Value**              | ** ** | **Instruments  Held**       | ** ** |
| ** **                         | ** ** | **January 1,  2010**                                          | ** ** | **Gains  (Losses)** | ** ** | **(Settlements),  Net**  | ** ** | **of  Level 3**        | ** ** | **March 31, 2010** | ** ** | **at  March 31, 2010** | ** ** |
| ** **                         | ** ** | **(In  thousands)**                                                | ** ** |
| Investments at  fair value         |       |                                                               |       |                |       |                     |       |                   |       |                         |       |                        |       |   |   |   |
| RMBS                               |       | $                                                                  | 2,631      |                | $          | 297                      |       | (1)                    | $          | (476                         | )          |                        | $          | — |   | $ | 2,452 |   | $ | 691 |   | (1) |
| Loans                              |       | 990                                                                |       | (9                  | )          | (1)                      | (69        | )                      |       | —                       |       | 912                         |       | (9 | ) | (1) |
| Other                              |       | 2,597                                                              |       | 2,110               |       | (1)                      | —     |                   |       | —                       |       | 4,707                       |       | 2,110 |   | (1) |
| Derivative assets                  |       | 74                                                                 |       | (48                 | )          | (2)                      | —     |                   |       | —                       |       | 26                          |       | (48 | ) | (2) |
| Total financial  instrument assets |       | $                                                                  | 6,292      |                | $          | 2,350                    |       |                   | $          | (545                         | )          |                        | $          | — |   | $ | 8,097 |   | $ | 2,744 |   |   |
|                               |       |                                                               |       |                |       |                     |       |                   |       |                         |       |                        |       |   |   |   |
| Accrued and other  liabilities     |       | $                                                                  | 364        |                | $          | 6                        |       | (3)                    | $          | (58                          | )          |                        | $          | — |   | $ | 312 |   | $ | 6 |   | (3) |

 

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(1)                                  Net realizedand unrealized gains (losses) on investments at fair value are reported withinnet gain on investments at fair value in the condensed consolidated statementsof operations.

 

(2)                                  Net realizedand unrealized gains (losses) on derivative assets are recorded in net loss onderivatives in the condensed consolidated statements of operations.

 

(3)                                  Net realizedand unrealized gains (losses) on accrued and other liabilities at fair valueare recorded within net loss on liabilities at fair value in the condensedconsolidated statements of operations.

 

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Thetable below includes a rollforward of the balance sheet amounts for the threemonths ended March 31, 2010 (including the change in fair value) forfinancial instruments classified within Level 3 of the valuation hierarchy forour Consolidated Investment Products segment. See further disclosure related tothe Consolidated Investment Products in Note 4.

 
| ** **                         | ** ** | ** **                                                         | ** ** | ** **          | ** ** | ** **               | ** ** | ** **             | ** ** | ** **                   | ** ** | **Changes  in Unrealized**  | ** ** |
|------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **Fair  Value Measurements Using Significant Unobservable Inputs** | ** ** | **Gains  (Losses)** | ** ** |
| ** **                         | ** ** | **Estimated**                                                      | ** ** | **Net  Realized/**  | ** ** | **Purchases,  (Sales),** | ** ** | **Net Transfers** | ** ** | **Estimated**                | ** ** | **Related  to Financial**   | ** ** |
| ** **                         | ** ** | **Fair  Value**                                                    | ** ** | **Unrealized**      | ** ** | **Issuances  and**       | ** ** | **In  (Out)**          | ** ** | **Fair  Value**              | ** ** | **Instruments  Held**       | ** ** |
| ** **                         | ** ** | **January 1,  2010**                                          | ** ** | **Gains  (Losses)** | ** ** | **(Settlements),  Net**  | ** ** | **of  Level 3**        | ** ** | **March 31, 2010** | ** ** | **at  March 31, 2010** | ** ** |
| ** **                         | ** ** | **(In  thousands)**                                                | ** ** |
| Investments at  fair value         |       |                                                               |       |                |       |                     |       |                   |       |                         |       |                        |       |   |   |   |
| Loans                              |       | $                                                                  | 19,080     |                | $          | 357                      |       | (1)                    | $          | 3,589                        |       |                        | $          | — |   | $ | 23,026 |   | $ | 197 |   | (1) |
| Corporate bonds                    |       | 12,890                                                             |       | 911                 |       | (1)                      | (4,027     | )                      |       | —                       |       | 9,774                       |       | 273 |   | (1) |
| Other                              |       | 477                                                                |       | 6                   |       | (1)                      | —     |                   |       | (376)                        |       | 107                         |       | 18 |   | (1) |
| Derivative assets                  |       | 15                                                                 |       | 10                  |       | (2)                      | —     |                   |       | —                       |       | 25                          |       | 10 |   | (2) |
| Total financial  instrument assets |       | $                                                                  | 32,462     |                | $          | 1,284                    |       |                   | $          | (438                         | )          |                        | $          | (376) |   | $ | 32,932 |   | $ | 498 |   |   |
|                               |       |                                                               |       |                |       |                     |       |                   |       |                         |       |                        |       |   |   |   |
| Long term debt                     |       | $                                                                  | 45,414     |                | $          | 34,749                   |       | (3)                    | $          | —                       |       |                        | $          | — |   | $ | 80,163 |   | $ | 32,950 |   | (3) |

 

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(1)                                  Net realizedand unrealized gains (losses) on investments at fair value are reported withinnet gain on investments at fair value in the consolidated statements ofoperations.

 

(2)                                  Net realizedand unrealized gains (losses) on derivative assets are recorded in net loss onderivatives in the consolidated statements of operations.

 

(3)                                  Net realizedand unrealized gains (losses) on accrued and other liabilities at fair valueare recorded within net loss on liabilities at fair value in the consolidatedstatements of operations.

 

***Assets measured at fair value on anonrecurring basis***

 

Certainassets are measured at fair value on a nonrecurring basis, meaning that theinstruments are measured at fair value only in certain circumstances (forexample, when held at the lower of cost or fair value). The following tablepresents the assets carried on the consolidated balance sheet by caption and bylevel within the ASC Topic 820 valuation hierarchy for which anonrecurring change in fair value was recorded during the three months ended March 31,2010 for our Principal Investing and Investment Management segments:

 
| ** **                                                   | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Carrying  Value** |
|--------------------------------------------------------------|------------|--------------------|------------|-------------|------------|-------------|------------|---------------------|
| ** **                                                   | ** ** | **(In thousands)** |
| Loans held for  sale                                         |       | $                  | —     |        | $          | —      |       | $                   | 436 |   | $ | 436 |
| Loans held for  investment, net of allowance for loan losses | —     |               | —     |        | 4,339      |        | 4,339      |
| Total assets at  fair value on a nonrecurring basis          |       | $                  | —     |        | $          | —      |       | $                   | 4,775 |   | $ | 4,775 |

 

Inthe table above, “Loans held for sale” includes changes in fair value of loanswhich are carried on the balance sheet at the lower of cost or fair value. “Loansheld for investment” represents loans for which a provision for loan losses wasrecorded during the three months ended March 31, 2010. One CDO managementcontract was fully impaired as of March 31, 2010 and is no longer carriedon the condensed consolidated balance sheet.

 

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The following table presentsthe total change in value of financial assets for which a fair value adjustmentwas included in the condensed consolidated financial statements during thethree months ended March 31, 2010 for our Principal Investing andInvestment Management Segment:

 
| ** **                            | ** ** | **Three months ended**  |
|---------------------------------------|------------|-------------------------|
| ** **                            | ** ** | **March 31, 2010** |
| ** **                            | ** ** | **(In thousands)**      |
| Loans  held for sale (1)              |       | $                       | (13) |
| Loans  held for investment (2)        |       | (4,253)                 |
| Intangible  assets, net (3)           |       | (168)                   |
| Total  nonrecurring fair value losses |       | $                       | (4,434) |

 

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(1)                                  Changes in thefair value of loans held for sale are reported within net gain on loans in thecondensed consolidated statements of operations.

 

(2)                                  Impairmentcharges to loans held for investment are reported within provision for loanlosses in the condensed consolidated statements of operations.

 

(3)                                  Impairmentcharges on intangible assets are reported within impairment of intangibleassets in the condensed consolidated statements of operations.

 

ASC Topic 820 requiresdisclosure of the fair value of financial instruments for which it is practicalto estimate that value. Estimated fair values presented below are calculated inaccordance with ASC Topic 820. With respect to securities for which the fairvalue option was not elected, quoted market prices, if available, are utilizedas estimates of fair values. In the absence of available quoted market prices,fair values have been derived based on our assumptions, the estimated amountand timing of future cash flows and estimated discount rates. Differentassumptions could significantly affect these estimates.

 

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The carrying amounts andestimated fair values of our financial instruments as of March 31, 2010for our Principal Investing and Investment Management segments, for which thedisclosure of fair values is required, were as follows:

 
| ** **                                            | ** ** | **As of March 31, 2010** |
|-------------------------------------------------------|------------|-------------------------------|
| ** **                                            | ** ** | ** **                    | ** ** | **Estimated** | ** ** |
| ** **                                            | ** ** | **Carrying**                  | ** ** | **Fair** | ** ** |
| ** **                                            | ** ** | **Value**                     | ** ** | **Value** | ** ** |
| ** **                                            | ** ** | **(In thousands)**            |
| Financial  assets:                                    |       |                          |   |   |
| Cash  and cash equivalents (1)                        |       | $                             | 36,289 |   | $ | 36,289 |
| Restricted  cash and cash equivalents (1)             |       | $                             | 29,451 |   | $ | 29,451 |
| Investments  at fair value (2)                        |       | $                             | 313,230 |   | $ | 313,230 |
| Other  investments (3)                                |       | $                             | 1,345 |   | $ | 1,345 |
| Derivative  assets (2)                                |       | $                             | 26 |   | $ | 26 |
| Loans  held for sale (2)                              |       | $                             | 517 |   | $ | 614 |
| Loans,  net of allowance for loan losses (2) (3) |       | $                             | 263,845 |   | $ | 244,747 |
| Investment  advisory fee receivables (1)              |       | $                             | 1,154 |   | $ | 1,154 |
|                                                  |       |                          |   |   |
| Financial  liabilities:                               |       |                          |   |   |
| Repurchase  agreements (1)                            |       | $                             | 277,623 |   | $ | 277,623 |
| Derivative  liabilities (2)                           |       | $                             | 236 |   | $ | 236 |
| Accrued  and other liabilities (2)                    |       | $                             | 312 |   | $ | 312 |
| Long  term debt:                                      |       |                          |   |   |
| Series A &  Series B Notes (4)     |       | $                             | 72,453 |   | $ | 55,000 |
| Subordinated  debt and securities (5) (6)        |       | $                             | 120,775 |   | $ | 49,868 |
| DFR  MM CLO (6)                                       |       | $                             | 217,296 |   | $ | 170,050 |
|                                                       |            |                               |  |  |  |  |  |

 

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(1)                                  Carryingamounts approximate the fair value due to the short term nature of theseinstruments.

 

(2)                                  The estimatedfair values were determined in accordance with ASC Topic 820.

 

(3)                                  It was notpracticable to estimate the fair value of certain loans and other investmentsbecause they are not traded in an active market; therefore, the carrying valuedisplayed is an approximation of fair value for loans with a carrying value of$81.5 million and other investments with a carrying value of$1.3 million as of March 31, 2010. If an independent pricing servicecan not provide fair value estimates for a given loan, we may determineestimated fair value based on some or all of the following: (a) currentfinancial information of the borrowing company and performance against itsoperating plan; (b) changes in the fair value of collateral supporting theloan; (c) changes to the market for the borrowing company’s service orproduct and (d) present value of projected future cash flows.

 

(4)                                  The estimatedfair values were calculated utilizing the guidance from ASC Topic 820. Weutilized the repayment amounts agreed upon, pursuant to the Senior NotesDischarge Agreement, to estimate fair value of the Series A & Series BNotes.

 

(5)                             Subordinateddebt and securities includes both our trust preferred securities (“TrustPreferred Securities”) and our Junior Subordinated Debt.

 

(6)                                  The estimatedfair values were calculated utilizing the guidance from ASC Topic 820. Weutilized comparable market data and internal models to calculate the estimatedfair value of the long term debt.

 

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The carrying amounts andestimated fair values of our financial instruments in our ConsolidatedInvestment Products segment as of March 31, 2010, for which the disclosureof fair values is required, are shown below. See further disclosure related tothe Consolidated Investment Products in Note 4.

 
| ** **                                | ** ** | **As of March 31, 2010** |
|-------------------------------------------|------------|-------------------------------|
| ** **                                | ** ** | ** **                    | ** ** | **Estimated** |
| ** **                                | ** ** | **Carrying**                  | ** ** | **Fair** |
| ** **                                | ** ** | **Value**                     | ** ** | **Value** |
| ** **                                | ** ** | **(In thousands)**            |
| Financial  assets:                        | ** ** | ** **                    | ** ** | ** ** |
| Restricted  cash and cash equivalents (1) |       | $                             | 160,392 |   | $ | 160,392 |
| Investments  at fair value (2)            |       | $                             | 2,199,578 |   | $ | 2,199,578 |
| Derivative  assets (2)                    |       | $                             | 25 |   | $ | 25 |
|                                      |       |                          |   |   |
| Financial  liabilities:                   |       |                          |   |   |
| Derivative  liabilities (2)               |       | $                             | 10,472 |   | $ | 10,472 |
| Long  term debt (3)                       |       | $                             | 2,069,394 |   | $ | 2,069,394 |

 

----

(1)                                  Carryingamounts approximate the fair value due to the short term nature of theseinstruments.

 

(2)                                  The estimatedfair values were determined in accordance with ASC Topic 820.

 

(3)                                  The estimatedfair values were calculated utilizing the guidance from ASC Topic 820. Weutilized comparable market data and internal models to calculate the estimatedfair value of the long term debt.

 

**6. OTHER INVESTMENTS**

** **

***Cost Method Investments***

 

As of March 31, 2010,we held certain other investments carried at cost less any adjustments forother-than-temporary impairment of $1.3 million. These investments consistof equity securities in the entities established in connection with theissuance of our trust preferred securities (the “Trust Preferred Securities”)of $0.8 million and other common and preferred equity securities that arenot traded in an active market with an original cost of $1.3 million and acarrying value of $0.5 million as of March 31, 2010.  We previously held $3.7 million of equitysecurities in the entities established in connection with the issuance of theTrust Preferred Securities; however, on March 4, 2010, $2.9 million ofequity securities were cancelled in connection with the Trust PreferredSecurities exchange agreement (the “Exchange Agreement”) as described in Note 12.

 

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**7. LOANS AND LOANS HELD FOR SALE**

 

The following summarizes ourloans held for sale and loans held for investment as of March 31, 2010:

 
| ** **                        | ** ** | **Carrying Value** |
|-----------------------------------|------------|--------------------|
| ** **                        | ** ** | **Loans Held**     | ** ** | **Loans Held** | ** ** | ** ** |
| **Type of Loan**                  | ** ** | **for Sale (1)**   | ** ** | **for Investment** | ** ** | **Total** |
| ** **                        | ** ** | **(In thousands)** |
| Corporate  leveraged loans:       |       |               |   |   |   |   |
| Loans  held in DFR MM CLO (2)     |       | $                  | — |   | $ | 267,156 |   | $ | 267,156 |
| Other  corporate leveraged loans  |       | 517                |   | — |   | 517 |
| Commercial  real estate loans (3) |       | —             |   | 9,453 |   | 9,453 |
|                              |       | $                  | 517 |   | 276,609 |   | 277,126 |
| Allowance  for loan losses        |       |               |   | (12,764) |   | (12,764) |
|                              |       |               |   | $ | 263,845 |   | $ | 264,362 |

 

----

(1)                                  Carrying valueof loans held for sale is lower of cost or estimated fair value.

 

(2)                                  Loans held inDFR MM CLO classified as loans held for investment are reported gross of $5.4million of allowance for loan losses as of March 31, 2010.

 

(3)                                  Commercial realestate loans are reported gross of $7.4 million of allowance for loanlosses as of March 31, 2010.

 

The following summarizes ourallowance for loan losses at March 31, 2010:

 
| ** **                    | ** ** | **Number**   | ** ** | **Par**            | ** ** | **Allowance**       |
|-------------------------------|------------|--------------|------------|--------------------|------------|---------------------|
| **Type of Loan**              | ** ** | **of Loans** | ** ** | **Value**          | ** ** | **for Loan Losses** |
| ** **                    | ** ** | ** **   | ** ** | **(In thousands)** |
| Loans  held in DFR MM CLO     |       | 4            |       | $                  | 9,798      |                | $ | 5,356 |
| Commercial  real estate loans |       | 3            |       | 8,058              |       | 7,408               |
| Total                         |       | 7            |       | $                  | 17,856     |                | $ | 12,764 |

 

As of March 31, 2010,our loans held for sale and loans held for investment totaled$264.4 million, net of allowance for loan losses. Loans classified as heldfor sale and carried at the lower of cost or estimated fair value totaled$0.5 million, net of a valuation allowance of $1.0 million as of March 31,2010. Loans classified as held for investment were carried at amortized costtotaling $276.6 million, less an allowance for loan losses of$12.8 million as of March 31, 2010. As of March 31, 2010, thenet carrying value of impaired loans was $4.3 million.

 

As of March 31, 2010,we held certain loans that settle interest accruals by increasing theoutstanding principal balance of the loan. For the three months ended March 31,2010, we settled interest receivables through increases to the loans’outstanding principal balances in the amount of $0.4 million.

 

Loans held in DFR MM CLO areconsidered to be held for investment and are reported at amortized cost with anallowance for loan losses, if necessary, unless we decide to sell one of theseloans, in which case the loan is transferred to loans held for sale and carriedat the lower of cost or estimated fair value.

 

As of March 31, 2010,our commercial real estate loans consisted of four loans classified as held forinvestment totaling $9.5 million less an allowance for loan losses of$7.4 million. We recognized $34,000 in interest income on one of theseloans for the three months ended March 31, 2010.

 

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The following summarizes theactivity within the allowance for loan losses for the three months ended March 31,2010 and 2009:

 
| ** **                                   | ** ** | **Allowance for Loan Losses** |
|----------------------------------------------|------------|-------------------------------|
| ** **                                   | ** ** | **2010**                      | ** ** | **2009** |
| ** **                                   | ** ** | **(In thousands)**            |
| Allowance  for loan losses at January 1 |       | $                             | 15,889 |   | $ | 19,979 |
| Provision  for loan losses                   |       | 4,194                         |   | 2,107 |
| Charge-offs                                  |       | (7,311)                       |   | — |
| Recoveries                                   |       | (8)                           |   | 85 |
| Allowance  for loan losses at March 31  |       | $                             | 12,764 |   | $ | 22,171 |

 

We did not recognize $0.8million of interest income earned, but not yet received, on loans held forinvestment for the three months ended March 31, 2010 as a result of theplacement of these loans on non-accrual status. In addition, we did notrecognize $0.7 million of interest income earned, but not yet received, onloans held for sale for the three months ended March 31, 2010 as a resultof the placement of these loans on non-accrual status. Our loans, loans heldfor sale and loans classified as investments at fair value are diversified overmany industries, and, as such, we do not believe we have any significantconcentration risk association with the composition of the loan portfolio.

 

**8. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES**

 

We seek to manage ourexposure to the effects of interest rate changes. Such exposure may arise fromthe issuance and forecasted rollover of short term liabilities or fromliabilities with a contractual variable rate based on the London InterbankOffered Rate (“LIBOR”). Derivative instruments are carried at fair value asdiscussed in Note 5.

 

The following table is asummary of our derivative instruments as of March 31, 2010 for ourPrincipal Investing and Investment Management segments:

 
| ** **          | ** ** | ** ** | ** ** | **Notional**        | ** ** | ** ** | ** ** | ** **      | ** ** | **Estimated Net** |
|---------------------|------------|------------|------------|---------------------|------------|------------|------------|-----------------|------------|-------------------|
| ** **          | ** ** | **Count**  | ** ** | **Amount**          | ** ** | **Assets** | ** ** | **Liabilities** | ** ** | **Fair Value**    |
|                |       |       |       | **(In  thousands)** |
| Interest  rate swap |       | 1          |       | $                   | 10,000     |       | $          | —          |       | $                 | (199) |   | $ | (199) |
| Interest  rate cap  |       | 1          |       | 40,000              |       | —     |       | (37)            |       | (37)              |
| Warrants            |       | 3          |       | n/a                 |       | 26         |       | —          |       | 26                |
|                |       | 5          |       | $                   | 50,000     |       | $          | 26              |       | $                 | (236) |   | $ | (210) |

 

----

n/a—not applicable

 

 

Thefollowing table is a summary of our derivative instruments as of March 31,2010 in the Consolidated Investment Products segment. See further disclosurerelated to the Consolidated Investment Products in Note 4.

 
| ** **          | ** ** | ** ** | ** ** | **Notional**       | ** ** | ** ** | ** ** | ** **      | ** ** | **Estimated Net** |
|---------------------|------------|------------|------------|--------------------|------------|------------|------------|-----------------|------------|-------------------|
| ** **          | ** ** | **Count**  | ** ** | **Amount**         | ** ** | **Assets** | ** ** | **Liabilities** | ** ** | **Fair Value**    |
| ** **          | ** ** | ** ** | ** ** | **(In thousands)** |
| Interest  rate swap |       | 1          |       | $                  | 172,400    |       | $          | —          |       | $                 | (10,472) |   | $ | (10,472) |
| Warrants            |       | 2          |       | n/a                |       | 25         |       | —          |       | 25                |
|                |       | 3          |       | $                  | 172,400    |       | $          | 25              |       | $                 | (10,472) |   | $ | (10,447) |

 

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The following table is asummary of the net loss on derivatives included in the condensed consolidatedstatements of operations:

 
| ** **               | ** ** | **Three months ended March 31,** |
|--------------------------|------------|---------------------------------------|
| ** **               | ** ** | **2010**                              | ** ** | **2009** |
| ** **               | ** ** | **(In thousands)**                    |
| Interest  rate swaps     |       | $                                     | (628) |   | $ | (173) |
| Credit  default swaps    |       | —                                |   | (120) |
| Warrants                 |       | (39)                                  |   | (111) |
| Net  loss on derivatives |       | $                                     | (667) |   | $ | (404) |

 

***Interest Rate Swaps***

 

In general, when afixed-rate or hybrid adjustable-rate RMBS is funded by a short term borrowing,our Principal Investing segment may enter into an interest rate swap agreementthat effectively fixes a portion of the borrowing costs for a period close tothe anticipated weighted-average life of the fixed-rate portion of the relatedRMBS. This strategy is designed to protect a portion of our portfolio fromincreased funding costs due to rising interest rates because the borrowingcosts are not fixed for the duration of the fixed-rate period of the relatedRMBS. With respect to the Consolidated Investment Products segment, interestrate swaps may be entered into by a CDO to protect it from a mismatch between anyfixed interest rates on its assets and the floating interest rates on its debt.

 

We did not enter into anyinterest rate swaps during the three months ended March 31, 2010. Theweighted average fixed rate payable on the interest rate swaps in the PrincipalInvesting and Consolidated Investment Products segments as of March 31,2010 was 5.86%.

 

***Interest Rate Cap***

 

Our interest rate cap isstructured such that we will receive payments based on the spread in rates ifthe three-month LIBOR rate increases above a certain agreed upon contractualrate, and we will make payments based on a nominal fixed interest rate. Thisinterest rate cap was entered into to manage interest rate exposure in DFR MMCLO.

 

***Warrants***

 

We hold warrants in both thePrincipal Investing and Consolidated Investment Products segments to purchaseshares of companies with respect to which we are also a debt holder. Thesewarrants were issued in connection with renegotiations of the loan agreements.

 

**9. FIXED ASSETS**

 

On November 27, 2009,we entered into an amendment (the “Lease Amendment”) to our original leaseagreement dated July 11, 2005 (as amended, the “Lease”). Pursuant to theLease Amendment, we vacated our original premises on April 30, 2010 andrelocated to 25,470 square feet of office space on the 12th floor in the samebuilding (the “New Premises”).

 

The term for the rental ofthe New Premises begins on October 1, 2010 and will expire on February 28,2021. As a result of the relocation to the New Premises, our annual rentexpense under the Lease will be reduced by approximately $1.3 million to reflectthe reduced square footage of the New Premises. In addition, pursuant to theLease Amendment, the amount of the letter of credit constituting our securitydeposit under the Lease was reduced from approximately $2.3 million toapproximately $1.3 million. The Lease Amendment provides for a furtherreduction of the amount of the letter of credit to $0.5 million on September 30,2010 upon the satisfaction of certain conditions.

 

In connection with the LeaseAmendment, we are recognizing a non-cash acceleration of depreciation andamortization expense related to certain leasehold improvements and fixed assetson the original premises as a result of a shorter estimated life for the use ofthose assets. The total impact of the acceleration of the depreciation andamortization expense is approximately $6.9 million, which we expensedratably from the date the Lease Amendment was signed (November 27, 2009)to the date on which we vacated the original premises (April 30, 2010).The impact of the accelerated depreciation for the three months ended March 31,2010 was approximately $4.1 million. As of March 31, 2010, we alsorecognized $0.3 million in additions to leasehold improvements and equipmentrelated to the New Premises.

 

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**10. REPURCHASE AGREEMENTS**

** **

Repurchase agreements areshort term borrowings from financial institutions that bear interest rates thathave historically moved in close relationship to the one-month, two-month orthree-month LIBOR. As of March 31, 2010, we had repurchase agreementsoutstanding in the amount of $277.6 million (including $26,000 of accruedinterest). As of March 31, 2010, the repurchase agreements had aweighted-average borrowing rate of 0.31%. and remaining maturities between 2and 30 days.

 

As of March 31, 2010,we had amounts at risk with the following repurchase agreement counterparties:

 
| ** **                               | ** ** | ** **             | ** ** | **Weighted-Average**       |
|------------------------------------------|------------|------------------------|------------|----------------------------|
| ** **                               | ** ** | ** **             | ** ** | **Maturity of Repurchase** |
| ** **                               | ** ** | **Amount at Risk (1)** | ** ** | **Agreements**             |
| **Repurchase Agreement Counterparties:** | ** ** | **(In thousands)**     | ** ** | **(In days)**              |
| Deutsche Bank  Securities Inc.           |       | $                      | 4,097      |                       | 8 |
| Fortis  Securities LLC                   |       | 4,079                  |       | 22                         |
| Total                                    |       | $                      | 8,176      |                       | 20 |

 

----

(1)                                  Equal to thefair value of securities pledged minus repurchase agreement liabilities andrelated accrued interest payable.

 

During the three monthsended March 31, 2010, repurchase agreement liabilities decreased by$13.9 million, primarily as a result of RMBS paydowns, which resulted inassociated repurchase agreement reductions. Our repurchase agreementliabilities are significantly concentrated with one counterparty through whichwe obtained financing for 86.1% of the $277.6 million of repurchaseagreement liabilities as of March 31, 2010. See Note 11 foradditional discussion concerning securities received and pledged as collateral.

 

**11. SECURITIES RECEIVED AND PLEDGED AS COLLATERAL**

 

To the extent that wereceive collateral in connection with derivative and repurchase agreementtransactions, we are generally permitted to sell or repledge these securities.As of March 31, 2010, we did not have any securities held as collateral. Wealso pledge our own assets to collateralize our repurchase agreements and inconnection with derivative transactions. These securities owned and pledged,where the counterparty has the right by contract or custom to sell or repledgethe financial instruments, were approximately $285.8 million as of March 31,2010 and consisted of securities pledged as initial collateral on repurchaseagreements. In addition, as of March 31, 2010, we had $0.8 million ofcash with counterparties as collateral on derivatives, which is included in Duefrom broker on the consolidated balance sheet.

 

Our largest repurchaseagreement counterparty has required that we maintain a minimum of$20.0 million of cash and certain eligible securities in the custody ofsuch counterparty in order to maintain our current repurchase agreement marginpercentages on our Agency RMBS. If we fail to satisfy this requirement, the counterpartywill have the right to immediately increase the margin percentage under therepurchase agreements and may exercise other remedies.

 

During the first quarter of2010, Fannie Mae and Freddie Mac announced and began to carry out plans to buy“substantially” all mortgages held in RMBS pools issued under their respectiveprograms that are delinquent by 120 days or more.  Primarily as a result of this action, werecorded $28.4 million in Other receivables as of March 31, 2010, whichqualified as eligible securities toward the $20.0 million discussed in theprevious paragraph.

 

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**12. LONG TERM DEBT**

 

The following tablesummarizes our long term debt:

 
| ** **                                    | ** ** | ** **         | ** ** | **Weighted** |
|-----------------------------------------------|------------|--------------------|------------|--------------|
| ** **                                    | ** ** | **Carrying**       | ** ** | **Average**  |
| ** **                                    | ** ** | **Value**          | ** ** | **Rate**     |
| ** **                                    | ** ** | **(In thousands)** | ** ** | ** **   |
| **Recourse:**                                 | ** ** | ** **         | ** ** | ** **   |
| Trust  Preferred Securities                   |       | $                  | 25,775     |         | 3.75% |
| Junior  Subordinated Debt                     |       | 95,000             |       | 1.00%        |
| Series A &  Series B Notes |       | 72,453             |       | 5.75%        |
| Total  Recourse                               |       | 193,228            |       | 2.66%        |
| **Non-Recourse:**                             |       |               |       |         |
| DFR  MM CLO (1)                               |       | 217,296            |       | 0.97%        |
| Consolidated  Investment Products (2)         |       | 2,069,394          |       | 0.83%        |
| Total  Non-Recourse                           |       | 2,286,690          |       | 0.84%        |
| Total  long term debt                         |       | $                  | 2,479,918  |         | 1.02% |

 

----

(1)          Excludes $19.0 millionof DFR MM CLO debt that is owned by us and eliminated upon consolidation. Hadthis debt been included, the weighted-average borrowing rate would be 1.23% asof March 31, 2010.

 

(2)          Includes the fair value ofthe preference shares in the carrying value, however, the preference shares donot have a stated interest rate.

 

*RecourseDebt*

 

Recourse debt refers to debt that is ourgeneral obligation.

 

*Junior Subordinated Debtand Trust Preferred Securities*

 

On March 4,2010, we entered into the ExchangeAgreement with Taberna Preferred Funding V, Ltd., Taberna PreferredFunding VII, Ltd., Taberna Preferred Funding VIII, Ltd. andTaberna Preferred Funding IX Ltd. (collectively, “Taberna”), to exchange$95.0 million of the $120.0 million aggregate outstanding principalamount of Trust Preferred Securities previously issued by our threewholly-owned indirect subsidiaries, Deerfield Capital Trust I, DeerfieldCapital Trust II and Deerfield Capital Trust III, for$95.0 million aggregate outstanding principal amount of junior subordinatednotes (the “Junior Subordinated Debt”)issued by us (the “Trust PreferredExchange”). The Trust Preferred Exchange was completed on March 4,2010. An aggregate of $25.0 million in principal amount of Trust PreferredSecurities issued by Deerfield Capital Trust I was not exchanged andremains outstanding.

 

The JuniorSubordinated Debt is governed by a junior subordinated indenture (the “New Indenture”), dated March 4,2010, between us and The Bank of New York Mellon Trust Company, NationalAssociation, as trustee. Pursuant to the New Indenture, the Junior SubordinatedDebt bears a fixed interest rate of 1.00% per annum from the date of issuancethrough April 30, 2015 or an earlier date upon which certain specifiedevents occur (the “Modification Period”).Thereafter, the Junior Subordinated Debt will be subject to a variable interestrate equal to LIBOR plus 2.58% per annum, payable quarterly on the thenoutstanding principal amount of the Junior Subordinated Debt until maturity on October 30,2035.

 

The New Indenture contains certain restrictivecovenants including, among other things, (i) a covenant that requires allasset management activities to be conducted by DFR and its subsidiaries, andwhich permits us to sell equity and material assets of DCM only if all assetmanagement fees and proceeds from equity and asset sales are subject to thelimits on restricted payments set forth in the New Indenture, (ii) a debtcovenant that permits DFR and DCM to incur indebtedness only if the proceeds ofsuch indebtedness are subject to the limits on restricted payments set forth inthe New Indenture and (iii) a restricted payments covenant that restrictsour ability to pay dividends or make distributions in respect of our equitysecurities, subject to a number of exceptions and conditions. If we fail tocomplete one or more transactions that in the aggregate result in the repaymentor refinancing of the Senior Notes upon terms that improve the credit positionof the 

 

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holders of the Junior Subordinated Debt by satisfying all of thefollowing conditions: (i) increased pro forma interest coverage; (ii) reducedpro forma debt-to-equity ratio; (iii) the aggregate principal amount ofany permitted refinancing indebtedness under the New Indenture is less than theaggregate principal amount of the Senior Notes; and (iv) after suchtransaction(s), the pro forma GAAP consolidated net worth of DFR is eitherpositive or has improved (a “CreditEnhancing Transaction”) within certain time periods, then theModification Period will terminate and certain exceptions to the restrictedpayments covenant will no longer be available to us. We currently expect thatthe issuance of the Convertible Notes and consummation of the Senior NotesDischarge will satisfy the requirement that we complete a Credit EnhancingTransaction. Unlike the indentures for the Trust PreferredSecurities, the New Indenture does not contain a covenant requiring us tomaintain a minimum net worth.

 

*Series A and Series BNotes*

 

On March 22, 2010,DFR and Deerfield entered into the SeniorNotes Discharge Agreement discussed in Note 3.

 

*Non-RecourseDebt*

 

Non-recoursedebt refers to debt with recourse only to specific assets pledged as collateralto the lenders, such as the debt issued by CDOs that are consolidated as VIEs.The creditors of non-recourse debt have no recourse to our other assets. Noneof our non-recourse debt is subject to potential margin calls for additionalpledges of cash or assets.

 

*DFR MMCLO*

 

Thecarrying value of the collateral held in DFR MM CLO, which are the only assetsto which the DFR MM CLO debt holders have recourse for repayment, was $279.3million as of March 31, 2010.

 

*ConsolidatedInvestment Products*

 

During the three months ended March 31, 2010,the CIP CDOs paid down $43.4 million of their outstanding debt. The carryingvalue of the collateral held in the CIP CDOs, which are the only assets to whichthe CIP CDOs debt holders have recourse for repayment, was $2.4 billion as of March 31,2010.

 

**13. STOCKHOLDERS’ EQUITY**

 

***Performance Shares***

 

There was no performanceshare activity during the three months ended March 31, 2010.  As of March 31, 2010, there were 308,164performance shares outstanding.

 

***Restricted Stock Grants***

 

As of January 1, 2010, we had one nonvested restricted stock grantoutstanding related to 433 shares of our common stock.  All of the 433 shares associated with therestricted stock grant vested during the three months ended March 31,2010, and we no longer have any outstanding restricted stock grants.

 

***Warrants***

 

On April 14, 2009, weannounced the formation of DPLC, our investment venture with Pegasus. Inconnection with the formation of DPLC, we issued to Pegasus Deerfield, anaffiliate of Pegasus, (i) a five-year warrant to purchase 2,500,000 sharesof our common stock at an exercise price of $4.25 per share (“Warrant A”) and (ii) afive-year warrant to purchase 500,000 shares of our common stock at an exerciseprice of $10.00 per share (“Warrant B” and, together with Warrant A, the “Warrants”).

 

On March 21, 2010, weentered into the Termination Agreement with the Pegasus Parties, the DeerfieldParties and Jonathan Trutter, our CEO, pursuant to which the Pegasus Partieswaived certain rights with respect to the issuance of the Stock Considerationand the issuance of the Conversion Shares. In addition, the Deerfield Partiesand the Pegasus Parties agreed to terminate or amend certain provisions ofagreements related to DPLC and cancel the Warrants.

 

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We also granted certain ofthe Pegasus Parties and their affiliates the DPLC Restructuring Warrants, whichare fully vested warrants to purchase 250,000 shares of our company’s commonstock at an exercise price of $4.25 per share. For the three months ended March 31,2010, we recognized $0.5 million of warrant expense related to the DPLCRestructuring Warrants in other general and administrative expense in thecondensed consolidated statement of operations. See Note 3 for more details.

 

**14. COMPUTATION OF NET INCOME (LOSS) PER SHARE**

 

The following table presentsthe calculation of basic and diluted net income (loss) per share:

 
| ** **                                                                            | ** ** | **Three months ended March 31,**     |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------|
| ** **                                                                            | ** ** | **2010**                                  | ** ** | **2009** |
| ** **                                                                            | ** ** | **(In thousands, except per share data)** |
|                                                                                  |       |                                      |   |   |   |
| **Net income (loss)**                                                                 |       | $                                         | (3,300 | ) |   | $ | 11,539 |
| Less:  Cumulative convertible preferred stock dividends  and accretion           |       | —                                    |   |   | — |
| **Net income (loss) attributable to common stockholders**                             |       | (3,300                                    | ) |   | 11,539 |
| Net  loss attributable to noncontrolling interest                                     |       | 3,163                                     |   |   | — |
| **Net income (loss) attributable to Deerfield Capital Corp.**                         |       | $                                         | (137 | ) |   | $ | 11,539 |
|                                                                                  |       |                                      |   |   |   |
| Weighted  average shares used in basic and diluted calculations                       |       | 6,763                                     |   |   | 6,702 |
|                                                                                  |       |                                      |   |   |   |
| **Net income (loss) attributable to Deerfield Capital Corp.****per  share - basic**   |       | $                                         | (0.02 | ) |   | $ | 1.72 |
|                                                                                  |       |                                      |   |   |   |
| **Net income (loss) attributable to Deerfield Capital Corp.****per  share - diluted** |       | $                                         | (0.02 | ) |   | $ | 1.72 |

 

For the three months ended March 31,2010, the 250,000 DPLC Restructuring Warrants that were issued and vested on March 22,2010 in connection with the Termination Agreement were not included in thecalculation of diluted net income (loss) per share because their effect wasanti-dilutive. For the three months ended March 31, 2010 and 2009,performance shares were included in the weighted average shares calculation butwere not included in shares outstanding. For the three months ended March 31,2009, restricted stock grants for 541 shares of our Common Stock were notincluded in the calculation of diluted net income (loss) per share becausetheir effect was anti-dilutive under the treasury stock method.

 

**15. INCOME TAXES**

 

We have recorded deferredincome taxes as of March 31, 2010 in accordance with ASC Topic 740 *— Income Taxes*(“ASC Topic 740”). We record deferred taxassets and liabilities for the future tax consequences attributable todifferences between the GAAP carrying amounts and their respective income taxbases. As required by ASC Topic 740, DFR evaluated the likelihood of realizingtax benefits in future periods, which requires the recognition of a valuationallowance to reduce any deferred tax assets to an amount that is more likelythan not to be realized.

 

As of March 31, 2010,we continued to record a full valuation allowance on our deferred tax asset.Accordingly, as of March 31, 2010, we have recognized a gross deferred taxasset of $356.9 million, a deferred tax liability of $3.4 million anda valuation allowance for deferred tax assets in the amount of$353.4 million. As such, we recognized no net deferred tax asset as of March 31,2010. For the three months ended March 31, 2010, the Investment Managementsegment recorded income tax expense of $400 related to Deerfield CapitalManagement (Europe) Limited.

 

As of March 31, 2010,we had a federal net operating loss (“NOL”) of approximately$235.3 million, which will begin to expire in 2028 if not used, and net capitallosses (“NCLs”) in excess of capital gains of approximately$429.4 million, which will begin to expire in 2012 if not used. Noassurance can be provided that we will have future taxable income or futurecapital gains to benefit from our NOL and NCL carryovers.

 

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In addition, the issuancesof shares of our Common Stock contemplated by the Acquisition Agreement willresult in an ownership change as defined in Sections 382 and 383 of theInternal Revenue Code of 1986, as amended (the “Code”) (“Ownership Change”).Generally, there is an Ownership Change if, at any time, one or more 5%shareholders (as defined in the Code) have aggregate increases in theirownership of more than 50 percentage points looking back over the relevanttesting period, which can occur as a result of acquisitions and certaindispositions of common stock by our 5% shareholders. As a result of theoccurrence of the Ownership Change, our ability to use our NOLs, NCLs andcertain recognized built-in losses to reduce our taxable income in a futureyear will generally be limited to an annual amount (the “Section 382Limitation”) equal to our fair value immediately prior to the Ownership Change,subject to certain adjustments, multiplied by the long term tax-exempt interestrate, which for the month of May is 4.03%. In the event of an OwnershipChange, NOLs and NCLs that exceed the Section 382 Limitation in any yearwill continue to be allowed as carryforwards for the remainder of thecarryforward period, and such NOLs and NCLs can be used to offset taxableincome for years within the carryforward period subject to the Section 382Limitation in each year. However, if the carryforward period for any NOL or NCLwere to expire before that loss was fully utilized, the unused portion of thatloss would be lost.

 

Our charter currently contains transfer restrictionsto prevent investors from aggregating ownership of our Common Stock andtriggering an Ownership Change. Since the issuance of the Acquisition Shareswill result in an Ownership Change, our board of directors (the “Board”) hasexempted the Stock Issuances from the restrictions set forth in Article IXof the charter. If the proposed transactions are consummated and theAcquisition Shares are issued to Bounty, our Board has agreed to terminate therestrictions on ownership and transfer contained in Article IX of thecharter.

 

**16. COST SAVINGS INITIATIVES**

 

In March and November 2008,in response to the adverse credit markets, we implemented cost savingsinitiatives (the “2008 Cost Saving Initiatives”) and reduced our headcount by37 employees, or approximately 28.5% of our pre-initiative workforce. Additionally,we reduced bonus compensation and instituted a salary freeze.

 

As of December 31, 2009, werecorded, as part of Accrued and other liabilities, $46,000 of remaining costsrelated to the 2008 Cost Savings Initiatives, which were all paid during the threemonths ended March 31, 2010.

 

**17. SEGMENT REPORTING**

 

Our business consists of three reportable segments: InvestmentManagement, Principal Investing and Consolidated Investment Products. Weevaluate the performance of the Investment Management and Principal Investingsegments (“DFR Operations”) based on segment results, expenses and revenues. Weseparately evaluate our Consolidated Investment Products segment based on itsresults, expenses and revenues, as the Consolidated Investment Products segmentexclusively consists of the CIP CDOs. The results for all segments also includedirect and allocated expenses and revenues. The following table provides a breakdown of ourcondensed consolidated statements of operations into segment-based components.DFR Operations for the three months ended March 31, 2010 is comparable toour consolidated GAAP results for prior periods.

 

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The following summarizes thefinancial information concerning our reportable segments (as described inNote 1):

 
| ** **                                                     | ** ** | **For  the three months ended March 31, 2010** |
|----------------------------------------------------------------|------------|-----------------------------------------------------|
| ** **                                                     | ** ** | **(In  thousands)**                                 |
| ** **                                                     | ** ** | **Investment  Management(1)**                       | ** ** | ** ** | **Principal  Investing(1)** | ** ** | ** ** | **DFR  Operations** | ** ** | **Consolidated  Investment  Products** | ** ** | ** ** | **Eliminations** | ** ** | ** ** | **Consolidated** | ** ** |
|                                                           |       |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest  income                                               |       | $                                                   | 6 |   |   | $ | 7,269 |   |   | $ | 7,275 |   |   | $ | 24,286 |   |   | $ | (59 | ) | (2) | $ | 31,502 |   |
| Interest  expense                                              |       | 1,213                                               |   |   | 1,785 |   |   | 2,998 |   |   | 4,755 |   |   | (59 | ) | (2) | 7,694 |   |
| Net  interest income (expense)                                 |       | (1,207                                              | ) |   | 5,484 |   |   | 4,277 |   |   | 19,531 |   |   | — |   |   | 23,808 |   |
| Provision  for loan losses                                     |       | —                                              |   |   | 4,186 |   |   | 4,186 |   |   | — |   |   | — |   |   | 4,186 |   |
| Net  interest income (expense) after provision for loan losses |       | (1,207                                              | ) |   | 1,298 |   |   | 91 |   |   | 19,531 |   |   | — |   |   | 19,622 |   |
| Investment  advisory fees                                      |       | 6,502                                               |   |   | — |   |   | 6,502 |   |   | — |   |   | (3,606 | ) | (3) | 2,896 |   |
| Total  net revenues                                            |       | $                                                   | 5,295 |   |   | $ | 1,298 |   |   | $ | 6,593 |   |   | $ | 19,531 |   |   | $ | (3,606 | ) |   | $ | 22,518 |   |
| Depreciation  and amortization                                 |       | $                                                   | 5,738 |   |   | $ | — |   |   | $ | 5,738 |   |   | $ | — |   |   | $ | — |   |   | $ | 5,738 |   |
| Income  tax expense                                            |       | $                                                   | — |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |
| Net  income (loss)                                             |       | $                                                   | (3,448 | ) |   | $ | 3,992 |   |   | $ | 544 |   |   | $ | (3,844 | ) |   | $ | — |   |   | $ | (3,300 | ) |
|                                                           |       |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                           |       | **As  of March 31, 2010**                      |   |
|                                                           |       | **(In  thousands)**                                 |
| Identifiable  assets                                           |       | $                                                   | 40,098 |   |   | $ | 675,850 |   |   | $ | 715,948 |   |   | $ | 2,383,348 |   |   | $ | (3,067) |   | (4) | $ | 3,096,229 |   |
|                                                           |       |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                                     | ** ** | **For  the three months ended March 31, 2009**      |   |   |   |   |   |   |   |   |   |   |
| ** **                                                     | ** ** | **(In  thousands)**                                 |   |   |   |   |   |   |   |   |   |   |
| ** **                                                     | ** ** | **Investment  Management(1)**                       | ** ** |   | **Principal  Investing(1)** |   |   | **Consolidated** |   |   |   |   |   |   |   |   |   |   |
|                                                           |       |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest  income                                               |       | $                                                   | 46 |   |   | $ | 13,736 |   |   | $ | 13,782 |   |   |   |   |   |   |   |   |   |   |
| Interest  expense                                              |       |                                                | 1,344 |   |   |   | 5,655 |   |   |   | 6,999 |   |   |   |   |   |   |   |   |   |   |
| Net  interest income (expense)                                 |       |                                                | (1,298 | ) |   |   | 8,081 |   |   |   | 6,783 |   |   |   |   |   |   |   |   |   |   |
| Provision  for loan losses                                     |       |                                                | — |   |   |   | 2,107 |   |   |   | 2,107 |   |   |   |   |   |   |   |   |   |   |
| Net  interest income (expense) after provision for loan losses |       |                                                | (1,298 | ) |   |   | 5,974 |   |   |   | 4,676 |   |   |   |   |   |   |   |   |   |   |
| Investment  advisory fees                                      |       |                                                | 4,737 |   |   |   | — |   |   |   | 4,737 |   |   |   |   |   |   |   |   |   |   |
| Total  net revenues                                            |       | $                                                   | 3,439 |   |   | $ | 5,974 |   |   | $ | 9,413 |   |   |   |   |   |   |   |   |   |   |
| Depreciation  and amortization                                 |       | $                                                   | 1,635 |   |   | $ | — |   |   | $ | 1,635 |   |   |   |   |   |   |   |   |   |   |
| Income  tax expense                                            |       | $                                                   | 18 |   |   | $ | — |   |   | $ | 18 |   |   |   |   |   |   |   |   |   |   |
| Net  income (loss)                                             |       | $                                                   | (3,386 | ) |   | $ | 14,925 |   |   | $ | 11,539 |   |   |   |   |   |   |   |   |   |   |
|                                                           |       |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                           |       |                                                |   | **As  of March 31, 2009** |   |   |   |   |   |   |   |   |   |   |   |
|                                                           |       | **(In  thousands)**                                 |   |   |   |   |   |   |   |   |   |
| Identifiable  assets                                           |       | $                                                   | 52,585 |   |   | $ | 933,734 |   |   | $ | 986,319 |   |   |   |   |   |   |   |   |   |   |
|                                                           |       |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                |            |                                                     |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Excludes the$0.7 million and $1.5 million of intercompany investment and advisory feesrevenues of the Investment Management segment and corresponding intercompanymanagement and incentive fee expense for the Principal Investing segmentrelated to the management agreement between the two segments for the threemonths ended March 31, 2010 and March 31, 2009, respectively.

 

(2)                                  Primarilyrepresents interest income and the corresponding interest expense earned by thePrincipal Investing segment on their investment in the Consolidated InvestmentProducts segment debt.

 

(3)                                  Primarilyrepresents internal fees charged to the Consolidated Investment Productssegment by the Investment Management segment for investment advisory services.

 

(4)                                  Represents thereceivable for fees charged to the Consolidated Investment Products segment bythe Investment Management segment which have not yet been paid by theConsolidated Investment Products segment.

 

The Principal Investingsegment results of operations include the financial results of DFR MM CLOand DPLC for the three months ended March 31, 2010.

 

**18. COMMITMENTS AND CONTINGENCIES**

 

***Legal Proceedings***

 

As previously reported, the SEC is conducting aninvestigation relating to certain practices associated with the offer, purchaseor sale of collateralized mortgage obligations and real estate mortgageinvestment conduits (“REMICs”) and the creation of re-REMICs.  Inconnection with this investigation, the SEC has requested and obtained certaininformation from DFR and DCM relating to certain mortgage securitiestransactions effected by DCM for DFR in 2005 and 2006.  In the event thatwe are subject to an SEC enforcement or other proceeding relating to thetransactions, we could be subject to significant monetary fines or otherdamages or penalties whether by enforcement action or via consensual settlementproceedings, and DCM could incur reputational damage as an investment manager.

 

In the ordinary course ofbusiness, we may be subject to legal and regulatory proceedings that aregenerally incidental to our ongoing operations. While there can be no assuranceof the ultimate disposition of such proceedings, we do not believe theirdisposition will have a material adverse effect on our consolidated financialstatements.

 

***2010 Interim Chairman CompensationAgreement***

 

On March 22, 2010, weentered into a letter agreement (“2010 Rothschild Compensation Agreement”) withPeter H. Rothschild setting forth the fees payable to him for his services asInterim Chairman of the Board for the year ended December 31, 2010. Mr. Rothschildhas been a member of the Board since December 2004 and the InterimChairman of the Board since April 19, 2007. The 2010 RothschildCompensation Agreement provides for a base fee during 2010, of $41,667 permonth and an expense reimbursement of $10,000 per month for expenses relatingto office space, information technology 

 

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and other items which Mr. Rothschildpays to his firm which provides him with office space and relatedinfrastructure. This agreement is subject to cancellation at any time at thediscretion of the compensation committee of the Board (the “CompensationCommittee”) as well as the occurrence of certain specified events. The 2010Rothschild Compensation Agreement also provides for two discretionary fees, a “CapitalTransaction Success Fee” not to exceed $1,000,000 and a “Non-CapitalTransaction Success Fee” not to exceed $500,000, which may be paid if certainspecified conditions are met. The conditions for payment of the discretionaryfees include, but are not limited to, Mr. Rothschild playing aninstrumental role in arranging and completing a strategic transaction thatsubstantially increases shareholder value. The Compensation Committee of theBoard has complete discretion over whether to award the Capital TransactionSuccess Fee and the Non-Capital Transaction Success Fee and over the amount ofthe fees and the portion payable as cash or non-cash compensation, and theCompensation Committee has not yet finally determined the amount of such feesto be paid in connection with the consummation of the transactions.

 

***Other Commitments and Contingencies***

 

We had unfunded investmentcommitments on bank loans of $2.4 million as of March 31, 2010. Thetiming and amount ofadditional funding on these bank loans are at the discretion of the borrower,to the extent the borrower satisfies certain requirements and provides certain documentation.

 

In connection withthe proposed strategic transactions with CNCIM and Bounty, our CompensationCommittee has discussed but not yet finally determined to award special bonusesto our officers and Mr. Rothschild upon consummation thereof. The aggregateamount of any such bonuses, together with any discretionary fees paid pursuantto the 2010 Rothschild Compensation Agreement, will not exceed$1.3 million.

 

**19. SUBSEQUENT EVENTS**

 

In connection with thepreparation of the consolidated financial statements, we evaluated subsequentevents after the balance sheet date of March 31, 2010. There have been nosignificant subsequent events since March 31, 2010 that would requireadjustment to or additional disclosure in these financial statements.

 

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

 

Thestatements in this discussion regarding the industry outlook and ourexpectations regarding the future performance of our business and the othernon-historical statements are forward-looking statements. These forward-lookingstatements are subject to numerous risks and uncertainties, including, but notlimited to, the risks and uncertainties described in this quarterly report on Form 10-Q(“Quarterly Report”) beginning on page 2 under the title “SpecialNote Regarding Forward Looking Statements” and in “*Part II — Item 1A. Risk Factors”* and in our AnnualReport on Form 10-K for the fiscal year ended December 31, 2009, asfiled with the Securities and Exchange Commission on March 23, 2010 (our *“*2009 10-K”) in “*Part I — Item 1A. Risk Factors.”* Youshould read the following discussion together with our condensed consolidatedfinancial statements and notes thereto included in*“Part I — Item 1. Financial Statements”* of thisQuarterly Report. Unless otherwise noted or the context otherwise requires, werefer to Deerfield Capital Corp. as “DFR,” to DFR and its subsidiaries as “we,”“us,” “our” or “our company,” to Deerfield & Company LLC, one of ourindirect wholly-owned subsidiaries, as “Deerfield” and to Deerfield CapitalManagement LLC, our former external manager and another of our indirectwholly-owned subsidiaries, as “DCM.” We refer to our acquisition of Deerfieldpursuant to a merger agreement, dated as of December 17, 2007, among us,DFR Merger Company, LLC (our wholly-owned subsidiary that was merged intoDeerfield), Deerfield and Triarc Companies, Inc. (“Triarc” (as sellers’representative)) by which DFR Merger Company, LLC was merged with and intoDeerfield on December 21, 2007 as the “Merger.”

 

**Overview**

 

We are a Marylandcorporation with an Investment Management segment that manages approximately$8.9 billion of client assets as of April 1, 2010, including bankloans and other corporate debt, residential mortgage-backed securities (“RMBS”),government securities and asset-backed securities (“ABS”). In addition, ourPrincipal Investing segment has an investment portfolio of approximately$581.5 million as of March 31, 2010, comprised of fixed incomeinvestments, including bank loans and other corporate debt and RMBS.

 

***Our Business***

 

Ourbusiness consists of three business segments: Investment Management, PrincipalInvesting and Consolidated Investment Products. Our Investment Managementsegment involves earning investment advisory fees for managing a variety ofinvestment products including collateralized debt obligations (“CDOs”),separately managed accounts and other investment vehicles. Our PrincipalInvesting segment involves maintaining an investment portfolio comprisedprimarily of bank loans and other corporate debt and Agency RMBS (as definedbelow). Agency RMBS are backed by mortgage loans and are guaranteed as toprincipal and interest by federally chartered entities such as the FederalNational Mortgage Association (“Fannie Mae”) or the Federal Home Loan MortgageCorporation (“Freddie Mac”) and, in the case of the Government NationalMortgage Association (“Ginnie Mae”), the U.S. government. We refer to theseentities as “Agencies” and to RMBS guaranteed or issued by the Agencies as “AgencyRMBS.” Our Agency RMBS portfolio consists of Fannie Mae and Freddie Macsecurities. We refer to our investments in senior secured loans (first lien andsecond lien term loans), senior subordinated debt facilities and other juniorsecurities, typically across a range of industries, as “Corporate Loans.”  In our Consolidated Investment Productssegment, we provide investment management services to seven CDOs (the “CIP CDOs”)that are consolidated as Variable Interest Entities (“VIEs”) consistent withAccounting Standards Codification (the “Codification”) Topic 810—*Consolidation*(“ASC Topic 810”) as amended by AccountingStandards Update (“ASU”) 2009-17 (“ASU 2009-17”). The Consolidated InvestmentProducts segment excludes DFR Middle Market CLO Ltd. (“DFR MM CLO”), whichis included in the Principal Investing segment because we own 100% of itspreference shares.

 

*Investment Management Segment*

 

Our Investment Managementsegment is operated through DCM. DCM manages investment accounts for varioustypes of clients, including CDOs, separately managed accounts (separate,non-pooled accounts established by clients) and other investment vehicles.Except for the separately managed accounts, these clients are collectiveinvestment vehicles that pool the capital contributions of multiple investors,which are typically financial institutions, such as insurance companies andbanks, employee benefits plans and “funds of funds” (investment funds that inturn allocate their assets to a variety of other investment funds). Our teamsthat manage these accounts are supported by various other groups within DCM,such as risk management, systems, accounting, operations and legal. DCM entersinto an investment management agreement with each client, pursuant to which theclient grants DCM certain discretion to purchase and sell securities and otherfinancial instruments.

 

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Our primary source ofrevenue from our Investment Management segment is the investment advisory feespaid by the accounts we manage. These fees typically consist of management feesbased on the account’s assets and, in some cases, performance fees based on theprofits we generate for the account.

 

***AUM***

 

As of April 1, 2010,DCM’s total assets under management (“AUM”) was approximately$8.9 billion, held in 28 CDOs, six separately managed accounts and oneother investment vehicle.

 

The following tablesummarizes the AUM for each of our product categories:

 
| ** **                       | ** ** | **As of April 1, 2010** |
|----------------------------------|------------|------------------------------|
| ** **                       | ** ** | **Number of**                | ** ** | ** ** |
| ** **                       | ** ** | **Accounts**                 | ** ** | **AUM** |
| ** **                       | ** ** | ** **                   | ** ** | **(In thousands)** |
| CDOs  (1):                       |       |                         |   |   |
| CLOs                             |       | 12                           |   | $ |  3,917,215 |
| Asset-backed  securities         |       | 12                           |   | 3,903,266 |
| Corporate  bonds                 |       | 4                            |   | 722,431 |
| Total  CDOs                      |       | 28                           |   | 8,542,912 |
| Separately  managed accounts (2) |       | 6                            |   | 320,568 |
| Other  investment vehicle (3)    |       | 1                            |   | 10,110 |
| Total  AUM (4)                   |       |                         |   | $ |  8,873,590 |

 

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(1)                                  CDO AUM numbersgenerally reflect the aggregate principal or notional balance of the collateraland, in some cases, the cash balance held by the CDOs and are as of the date ofthe last trustee report received for each CDO prior to April 1, 2010. TheAUM for our Euro-denominated CDOs has been converted into U.S. dollars usingthe spot rate of exchange as of the respective AUM date.

 

(2)                                  AUM for certainof the separately managed accounts is a multiple of the capital actuallyinvested in such account. Management fees for these accounts are paid on thishigher AUM amount.

 

(3)                                  Otherinvestment vehicle AUM represents the AUM of Deerfield Pegasus Loan Capital LP(“DPLC”).

 

(4)                                  Included inTotal AUM for April 1, 2010 is $279.7 million related to DFR MM CLO.DCM manages DFR MM CLO but is not contractually entitled to receive anymanagement fees so long as 100% of the preference shares are held by DeerfieldCapital LLC (“DC LLC”) or an affiliate thereof.

 

*PrincipalInvesting Segment*

 

Income from our PrincipalInvesting segment is influenced by four factors: (i) the nominal amount ofinterest income we earn on our investment portfolio and the net spread, ordifference, between the interest income we earn on our investment portfolio andthe cost of our borrowings net of hedges, if any, (ii) the net recognizedgains and losses, if any, on our investment portfolio, (iii) provision forloan losses, if any, and (iv) the volume or aggregate amount of suchinvestments. We use leverage to seek to enhance our returns, which can alsomagnify losses. The cost of borrowings to finance our investments comprises asignificant portion of our operating expenses.

 

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The following table is asummary of our Principal Investing segment by asset class:

 
| ** **                                   | ** ** | **March 31, 2010** |
|----------------------------------------------|------------|-------------------------|
| ** **                                   | ** ** | **Carrying**            | ** ** | **% of Total** |
| **Principal Investing**                      | ** ** | **Value**               | ** ** | **Investments** |
| ** **                                   | ** ** | **(In thousands)**      | ** ** | ** ** | ** ** |
|                                         |       |                    |   |   |   |
| RMBS  (1)                                    |       | $                       | 303,258 |   |   | 51.0% |
| Corporate  leveraged loans:                  |       |                    |   |   |   |
| Loans  held in DFR MM CLO                    |       | 267,156                 |   |   | 45.0% |
| Other  corporate leveraged loans             |       | 517                     |   |   | 0.1% |
| Loans  held in DPLC                          |       | 5,265                   |   |   | 0.9% |
| Commercial  real estate loans and securities |       | 9,453                   |   |   | 1.6% |
| Equity  securities                           |       | 1,345                   |   |   | 0.2% |
| Other  investments                           |       | 7,234                   |   |   | 1.2% |
| **Total Investments**                        |       | 594,228                 |   |   | 100.0% |
| Allowance  for loan losses                   |       | (12,764                 | ) |   |   |
| **Net Investments**                          |       | $                       | 581,464 |   |   |   |

 

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(1)                                  RMBS are eitherAgency RMBS or non-Agency RMBS. As of March 31, 2010, non-Agency RMBSrepresented $2.5 million.

 

*ConsolidatedInvestment Products*

 

The Consolidated InvestmentProducts segment was established on January 1, 2010 in accordance with theamendments to the consolidation guidance in the Financial Account StandardsBoard (“FASB”) ASC Topic 810. We provide investment management services to the CIPCDOs and earn contractually-negotiated management fees for providing ourservices to the CIP CDOs.  Managementfees vary by contract and performance of the products, but may include seniorfees, subordinated fees and incentive fees. DFR MM CLO is not included in theConsolidated Investment Products segment but is included in the PrincipalInvesting segment because we own 100% of its preference shares.

 

The following table is asummary of our Consolidated Investment Products segment by asset class:

 
| ** **                           | ** ** | **March 31, 2010** |
|--------------------------------------|------------|-------------------------|
| ** **                           | ** ** | **Carrying**            | ** ** | **% of Total** |
| **Consolidated Investment Products** | ** ** | **Value**               | ** ** | **Investments** |
| ** **                           | ** ** | **(In thousands)**      | ** ** | ** ** |
|                                 |       |                    |   |   |
| Loans                                |       | $                       | 1,990,929 |   | 90.5% |
| Corporate  bonds                     |       | 208,166                 |   | 9.5% |
| Other  investments                   |       | 483                     |   | 0.0% |
| **Total Investments**                |       | $                       | 2,199,578 |   | 100.0% |

 

**Our Strategy**

 

Our strategies to achievegrowth center on four areas: (i) the acquisition of existing CDOcontracts from other managers, (ii) the internal development of newproduct offerings relying on existing capabilities, (iii) the introductionof new products resulting from acquisitions of and ventures with externalmanagers and (iv) the creation of new CLO structures as the marketenvironment improves and the economics for new issuances become attractive toinvestors.

 

On March 23, 2010, weannounced our entry into a definitive agreement with Bounty Investments, LLC (“Bounty”)and Columbus Nova Credit Investments Management, LLC (“CNCIM”) to acquire allof the outstanding equity interests of CNCIM from Bounty which will provide asignificant increase in our AUM and management fee income, and the other 

 

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related transactions will result in theelimination of our near-term debt maturities, reduce our total debt and removea number of restrictive debt covenants. As a result of the transactions with Bounty, we believe the ongoingrelationship between us and Bounty will result in opportunities for us to growboth organically and via acquisitions that may not have otherwise beenavailable to us. See “*Proposed StrategicTransactions”*later in this section for more details.

 

We are focused on growingthe Investment Management segment of our business by launching new investment productsthat will diversify our revenue streams and take advantage of our corecompetencies of credit analysis and asset management. We intend to makeinvestments in certain of these new investment products. We believe that thegrowth of fee-based income through the management of alternative investmentproducts will provide the most attractive risk-adjusted return on capital.

 

We are focused on managingour Principal Investing segment by opportunistically redeploying our capitalinto other fee-based strategies. In the near term, we expect to continue tohold our RMBS portfolio both for the net interest income it provides and as asource of liquidity.

 

**Proposed Strategic Transactions**

 

*The Acquisition and Issuance of the Acquisition Shares*

 

On March 22, 2010, weentered into an Acquisition and Investment Agreement (the “Acquisition Agreement”) with Bountyand CNCIM, pursuant to which we agreed to acquire all of the outstanding equityinterests of CNCIM from Bounty (the “Acquisition”)for a total purchase price of $32.5 million consisting of (i) theissuance of 4,545,455 shares (at an implied price of $5.50 per share) (the“Acquisition Shares”) of our common stock, par value $0.001 pershare (the “Common Stock”) and (ii) deferred payments totaling$7.5 million in cash payable in five equal annual installments beginningsix months after the closing date of the Acquisition and the issuance of theConvertible Notes (the “Closing Date”).The final purchase price for accounting purposes will be determined at theClosing Date which is contingent upon shareholders approval of the issuance ofthe Acquisition Shares and the Conversion Shares (as defined below).

 

Wehave agreed to pay the cost of transferring the operations of CNCIM asestimated on the Closing Date, which are currently anticipated to beapproximately $1.2 million. Bounty has agreed to pay the costs in excessof such amount. Bounty has also agreed to indemnify us for losses relating toCNCIM’s operating liabilities arising prior to the Closing Date (other thanliabilities under certain employment agreements, liabilities relating to theCNCIM CLOs’ management agreements, liabilities relating to actions takenpursuant to a Transition Services Agreement with Bounty and CNCIM, pursuant towhich we are providing services to CNCIM in connection with CNCIM’s managementof the CNCIM CLOs (“Transition Services Agreement”) and the expenses of thetransfer of operations) for one year from the Closing Date, as well as certainpre-closing tax liabilities for three years from the Closing Date, up to$5.0 million in the aggregate.

 

TheAcquisition Agreement contains customary covenants of CNCIM and us, includingwith respect to the operation of their respective businesses between the dateof the Acquisition Agreement and the Closing Date. The consummation of thetransactions contemplated by the Acquisition Agreement (the “Closing”) is subject to severalclosing conditions, including, among other things, the approval by ourstockholders of the issuance of the Acquisition Shares and the potentialissuance of the Conversion Shares (as defined below), collectively referred toas the “Stock Issuances,” the consummation of the Senior Notes Discharge, theabsence of certain governmental constraints and the absence of a materialadverse effect on our business of that of CNCIM.

 

*The Convertible Notes Agreement and Potential Issuance ofthe Conversion Shares*

 

On March 22, 2010,in connection with entering into the Acquisition Agreement, we entered into aSenior Subordinated Convertible Notes Agreement (the “Convertible Notes Agreement”) with Bounty pursuant to whichBounty has agreed to purchase for cash $25.0 million in aggregateprincipal amount of our senior subordinated convertible notes (the “Convertible Notes”), convertible into4,132,231 shares of Common Stock (as such amount may be adjusted incertain events or increased in connection with the payment of interest-in-kind(“PIK Interest”)) (the “ConversionShares”) at an initial conversion price of $6.05 per share, subject toadjustment.

 

We may issue and sell upto an additional $25.0 million of Convertible Notes under the ConvertibleNotes Agreement, subject to Bounty’s approval, although we have no agreementwith respect to any such additional issuances at this time. The holders of ConvertibleNotes will have the right, at any time, to convert the principal amount of theConvertible Notes held by such holders into Conversion Shares at the conversionrate, which will initially be approximately 165.29 shares per $1,000principal amount of Convertible Notes (the “Conversion Rate”) (equal to a conversion price of $6.05 pershare), and is subject to adjustment from time to time for specified events.

 

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We intend to closethe issuance and sale of the Convertible Notes to Bounty simultaneously withthe closing of the Acquisition on the Closing Date. All Convertible Notesissued on the Closing Date or thereafter will mature on the date that is sevenyears and six months following the Closing Date. Interest on the ConvertibleNotes will be payable to the holders of the Convertible Notes quarterly inarrears on each January 1, April 1, July 1 and October 1.We will pay interest in cash at a per annum rate starting at 8% and increasingto 11% depending on the interest period in which interest is due and payable;provided, that we may, in our sole discretion and upon notice to the holders ofthe Convertible Notes, elect to pay up to 50% of the interest payment due toany holder of the Convertible Notes in PIK Interest subject to certainconditions.*TheSenior Notes Discharge*

 

On March 22, 2010,DFR and Deerfield entered into a Payment Agreement and Release (the “Senior Notes Discharge Agreement”)with the holders of the Series A Senior Secured Notes issued by Deerfield(the “Series A Notes”) andthe holders of the Series B Senior Secured Notes issued by Deerfield (the “Series B Notes” and, togetherwith the Series A Notes, the “SeniorNotes”), pursuant to which we have agreed with the holders of the SeniorNotes to discharge all of the approximately $48.8 million in aggregateprincipal amount of Series A Notes outstanding at approximately 64.1% ofthe principal amount thereof plus accrued interest, and all of theapproximately $25.1 million in aggregate principal amount of the Series BNotes outstanding at approximately 94.5% of the principal amount thereof plusaccrued interest, or an aggregate discount of approximately 25.6% from the faceamount of the Senior Notes plus accrued interest (the “Senior Notes Discharge”). We are required to consummate theSenior Notes Discharge if we complete one or more debt or equity financingtransactions or recapitalization transactions (or any combination of debt orequity financing and recapitalization transactions), which result in cashproceeds to DFR or Deerfield in an aggregate amount of at least$25 million on or prior to July 31, 2010. The issuance of theConvertible Notes would trigger this requirement. We intend to use the proceedsof the issuance of the Convertible Notes, together with other available funds,to effect the Senior Notes Discharge. Upon consummation of the Senior NotesDischarge, all obligations and liabilities of DFR and Deerfield under theSenior Notes will be released and the intercreditor agreement related to theSenior Notes will be terminated.

 

Effective upon the dateof the Senior Notes Discharge Agreement, we released certain of the holders ofthe Senior Notes from their obligation to indemnify us for losses related tocertain matters pursuant to the terms of the Merger Agreement (whichindemnification obligations would otherwise have remained in effect until June 30,2010).

 

*The DPLC Restructuring*

 

We announced on March 22,2010 that we entered into a Termination Agreement (the “Termination Agreement”) with Pegasus Deerfield (AIV), LLC,(“Pegasus Deerfield”), PGSManagement, LLC, (“PM”,and together with the Pegasus Deerfield, the “Pegasus Parties”), DPLC, DCM, DPLC General Partner LLC (“DPLC GP”), Deerfield LoanManager LLC (“DLM” andtogether with DFR, DCM and DLM, the “DeerfieldParties”) and Jonathan Trutter, pursuant to which (i) the PegasusParties waived certain rights with respect to the Stock Issuances and (ii) theDeerfield Parties and the Pegasus Parties terminated or amended certainprovisions of agreements related to DPLC and cancelled warrants to purchasethree million shares of our Common Stock, which is all of the warrantspreviously issued to the Pegasus Parties (the “DPLC Restructuring”). Pursuant to the Termination Agreement,DPLC GP and DPLC released all partners of DPLC from their unfunded capitalcommitments to DPLC as of the date of the Termination Agreement. In addition,DPLC made distributions of $9.0 million to the Pegasus Deerfield and anamount equal to his entire capital account balance to Jonathan Trutter.DPLC GP also withdrew an amount equal to the entire portion of its capitalaccount attributable to DLM’s investment in DPLC GP and distributed suchamount to DLM, our wholly-owned subsidiary. Additionally, we granted thePegasus Investor and certain of its associates warrants to purchase anaggregate of 250,000 shares of common stock at an exercise price of $4.25per share (“DPLC Restructuring Warrants”). Pegasus Deerfield has also notified us that they intend to withdrawtheir entire remaining capital account balance.

 

**Trends**

 

We have identified thefollowing trends that may affect our business:

 

*Creditmarket dislocation.*  Thewell-publicized disruptions in the financial markets that began in 2007 andescalated throughout 2008 significantly diminished through the second half of2009 and into the first quarter of 2010. The numerous programs implemented bythe U.S. government aimed at stabilizing credit markets and improving overallfinancial system liquidity show signs of having the desired effect. Among thesigns of returning stability and confidence in financial markets was a strongincrease in equity markets with the Dow Jones Industrial Average and theS&P 500 advancing by 29% and 27%, respectively, from June 30,2009 until March 31, 2010. Further contributing to a sense of returningnormalcy was the relative stability of treasury yields. On balance, rates alongthe yield curve changed by less than 14 basis points from  December 31, 

 

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2009 to March 31, 2010. The trailing100 day volatility on the 10 year Treasury bond declined from 52.5%at June 30, 2009 to 27.2% at December 31, 2009 to 22.7% as of March 31,2010 . While we certainly cannot predict the long-term effect that theseprograms will have on financial markets or our business, we have observed thatthe massive liquidity provided by the government via the numerous programs itimplemented had the effect of raising prices and lowering risk premiums.

 

*Financial Reform*.  The dislocations referred to above causedwidespread damage to the economy, significant loss of jobs and necessitatednumerous bailout programs to moderate the negative impacts of the recenteconomic downturn. The U.S. federal government has expressed interest inundertaking financial reforms intended to prevent a recurrence of the 2008-2009disruptions. Among the proposals that have been implemented or are beingconsidered are limits on executive pay, new restrictions on the creation andtrading of derivative securities, separating the trading and lending activitiesof commercial banks and a number of other ideas. As these reforms move towardfinal form, we will assess their impact on our business and adjust accordingly.

 

*Liquidity.*  A significant portion of the investments inour Principal Investing portfolio are financed. We depend on a variety offinancial institutions to provide that financing. Historically, we havefinanced our RMBS portfolio using repurchase agreements. Events in 2008 causedmany financial institutions to change their credit standards and generallyreduced the amount of repurchase agreements available to borrowers, resultingin a decrease in overall market liquidity. This trend has reduced the number offinancial institutions with which we conduct repurchase financings and, in2008, prompted us to sell a significant portion of our RMBS portfolio at a timewhen we would not otherwise have chosen to do so. Prompted in part by theimpact of the government actions noted above, we believe some additionalcapacity in repurchase financing is now returning to the market. However, ifour current lenders are unwilling or unable to provide us with continuedfinancing and we can not secure financing elsewhere, we could be forced to sella large portion of our RMBS portfolio at an inopportune time or on unfavorableterms. Because the majority of our current RMBS portfolio consists of AgencyRMBS, we believe that we are better positioned to convert our investmentsecurities to cash or to negotiate an extended borrowing term should ourlenders reduce the amount of the financing available to us.

 

*Corporatecredit performance.*  Corporatedefault rates have increased over the past year as the U.S. economy weakenedand financial markets deteriorated. As noted above, stock prices have recentlyrisen, and corporate earnings reports for many companies point to improvingeconomic conditions. Although there may be some further cyclical increase incorporate defaults over the coming months, we expect government stimulusprograms and improving economic conditions to begin moderating the pace of suchdefaults. If the stimulus packages are not effective in promoting growth, it ispossible that recent signs of improvement will give way to renewed economicweakness. A further weakening of the U.S. economy would likely result in furtherincreases in corporate default rates. Such increases would likely furtherreduce the returns associated with certain of our investments, particularly theCorporate Loans held in both our Principal Investing portfolio and in certainof the vehicles managed within our Investment Management segment. Increases indefaults could also cause us to trigger or prolong the effects of certainstructural provisions in the CDOs that we own and manage. These structuralprovisions include, but are not limited to, overcollateralization requirementsthat are meant to protect investors from deterioration in the credit quality ofthe underlying collateral pool.

 

*Creditspreads.*  Beginning inthe second half of 2007, credit markets experienced significantly higher yieldsand wider spreads versus Treasury securities. For example, the yield spread onthe Barclay’s High Yield Bond Index increased from 295 basis points overTreasuries at June 30, 2007 to a peak of 1830 basis points in November of2008. The widening of credit spreads evidenced by that index was pervasive andresulted in a decline over that period in the fair value for most of ourinvestments and in the securities we manage. The second half of 2009 saw adramatic narrowing of credit spreads, as evidenced by the spread on theBarclays High Yield Bond Index falling from 945 basis points as of June 30,2009 to 570 basis points as of March 31, 2010. This narrowing of spreadshas had a positive influence on the fair value of many of our investments, butmay also have the effect of reducing the future attractiveness of suchinvestments and reducing future net interest income.

 

*Yieldcurve.*  During 2009, the yield curvesteepened, with the yield differential between 6 month Treasury bills and10 year Treasury notes increasing from 1.95% to 3.65%. The most dramaticsteepening occurred in the first half of 2009 as the yield differential between6 month Treasury bills and 10 year Treasury notes at June 30,2009 grew to 3.19%. In the second half of the year, the spread fluctuatedbetween a low of 3.03% and a high of 3.65% which is where it finished theyear.  In the first quarter of 2010, theyield curve was relatively stable, with the spread between 6 month treasurybills and 10 year Treasury notes narrowing by only 5 basis points from 3.65% atDecember 31, 2009 to 3.60% at March 31, 2010. Since our earnings arederived in part from the rate difference between the cost of our fundingsources (such as repurchase agreements) and the earning rate of the assetspurchased (such as RMBS) changes in the yield curve can impact our earnings.Historically, we attempted to limit our exposure to this risk by engaging invarious types of hedging activities such as the use of interest rate swaps.More recently, we have reduced our hedging activities and are operating with alarger duration gap. 

 

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This decision has had the near-term effect ofincreasing the net interest income on our RMBS portfolio; however, if shortterm yields rise in relation to intermediate term yields (a flattening of theyield curve), we would likely experience a reduction in net interest income.

 

*CDOfinancing and management.*  Thereduction in liquidity and widening of credit spreads resulted in significantdownward pressure on the fair values of assets typically held in and financedby CDOs in 2009. These decreased fair values, along with increased defaultrates on assets held in CDOs and significant rating agency downgrades of thecollateral underlying certain of our CDOs, caused our CDOs to trigger certainof their structural provisions and reduced our management fees and our AUM. See“*Results of Operations—Investment ManagementSegment—CDOs*” for further information.

 

The improving economicenvironment raises the possibility that the pace of new CLO issuance mayincrease during the remainder of 2010. While we have seen a modest number ofnew CLOs launched in the first quarter of 2010, it is very difficult todetermine if or when we will have additional newly-formed CLOs undermanagement. While overall conditions in the credit markets appear to beimproving, there has been a significant reduction in the number of bankswilling to provide warehouse financing for CLO collateral and, in those caseswhere financing is available, the banks are charging significantly higher feesand interest rates in addition to requiring more capital from borrowers.Similarly, potential investors are demanding significantly higher interestrates on CLO liabilities. To the extent that we are successful in creating newCLOs, the management fees we earn from managing these new CLOs may besignificantly lower, and we may be required to invest more of our capital intoa new CLO, which may negatively affect our ability to grow our AUM and revenue.

 

During 2008 and 2009, theCDO management market experienced some consolidation, evidenced by CDOmanagement contracts being transferred to or acquired by other investmentmanagers. On July 17, 2008, we acquired the management contract for RobecoCDO II Limited (“Robeco CDO”), and, on February 11, 2009, we assumed themanagement contract for Mayfair Euro CDO I.B.V. (“Mayfair Euro CDO”). In addition on March 23, 2010, weannounced our entry into a definitive agreement with Bounty and CNCIM toacquire all of the outstanding equity interests of CNCIM, an investment managerwith four CLOs under management, from Bounty, which will provide a significantincrease in our CDO AUM and management fee income. We expect thisconsolidation trend to continue in the near term, and we continue to pursue theacquisition and assumption of additional management contracts.

 

*Valuationof investments.*  Fewerfinancing options and tighter lending standards had the widespread effect offorcing investors to offer for sale a significant amount of investment assetsunder distressed market circumstances. This increase in investment assets forsale, together with investors’ diminished confidence in their ability to assessthe quality of credit-sensitive investments, caused significant pricevolatility in previously stable asset classes. As a result, the valuationprocess for certain types of investments has become more uncertain andsubjective, and prices obtained through such process may not necessarilyrepresent what we would receive in an actual sale of a given investment.

 

**CriticalAccounting Policies**

 

Ourfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”). These accountingprinciples require us to make some complex and subjective judgments andestimates. Our most critical accounting policies involve judgments andestimates that could affect our reported assets and liabilities, as well as ourreported revenues and expenses. We believe that all of the judgments andestimates inherent in our financial statements were reasonable, based uponinformation available to us. We rely on management’s experience and analysis ofhistorical and current market data in order to arrive at what we believe to bereasonable estimates. Under varying conditions, we could report materiallydifferent amounts arising under these critical accounting policies. We believethat the critical accounting policies upon which our financial condition andresults of operation depend, and which involve the most complex subjectivedecisions or assessments, are included in the discussion entitled “CriticalAccounting Policies” in “*Part II — Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations*” in our 2009 10-K. There have been no material changes tothe critical accounting policies disclosed in our 2009 10-K except as indicatedbelow.

 

*Recent Accounting Updates*

 

In June 2009, the FASBissued SFAS No. 167, *Amendments to FASBInterpretation No. 46(R) *(“SFAS No. 167”). In December 2009,the FASB issued ASU 2009-17 to revise the Codification to include SFAS No. 167within ASC Topic 810. In February 2010, the FASB issued ASU 2010-10, *Amendments for Certain Investment Funds*(“ASU 2010-10”), to defer theeffective date of the amendments to the consolidation requirements of ASC Topic810 resulting from the issuance of ASU 2009-17 for reporting entities withinterests in entities with all the attributes of an investment company butspecifically excluding interests in securitization entities.  This statement was issued to address concernsabout financial statement 

 

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preparers’ ability to structure transactionsto avoid consolidation, balanced with the need for more relevant, timely andreliable information about an entity’s involvement in a VIE. This statementrequires an enterprise to perform an analysis to determine whether theenterprise’s variable interest or interests give it a controlling financialinterest in a VIE. This analysis identifies the primary beneficiary of a VIE asthe enterprise that has both the power to direct the activities of a VIE thatmost significantly impact the entity’s economic performance and the obligationto absorb losses of the entity that could potentially be significant to the VIEor the right to receive benefits from the entity that could potentially besignificant to the VIE. Additionally, an enterprise is required to assesswhether it has an implicit financial responsibility to ensure that a VIEoperates as designed when determining whether it has the power to direct theactivities of the VIE that most significantly impacts the entity’s economicperformance. The amendments to ASC Topic 810 also amend FIN 46(R) toeliminate the quantitative approach to determining the primary beneficiary of aVIE and requires ongoing reassessments of VIE status.  We adopted the amendments to ASC Topic 810 onJanuary 1, 2010.

 

Beginning January 1,2010, as a result of our adoption of the amendments to ASC Topic 810, weconsolidated the CIP CDOs and created our Consolidated Investment Productssegment. DFR MM CLO is not included in the Consolidated Investment Productssegment but is included in the Principal Investing segment because we own 100%of its preference shares. The impact of consolidating the CIP CDOs into ourcondensed balance sheet as of March 31, 2010 is an increase to totalassets of $2.4 billion, an increase in total liabilities of $2.1 billion and anincrease in total stockholders’ equity of $235.5 million, including acumulative effect from the adoption of the amendments to ASC Topic 810 of$244.9 million as of January 1, 2010. The impact of consolidating the CIPCDOs into our condensed consolidated statement of operations for the threemonths ended March 31, 2010 was an increase in total revenues of $19.5million, an increase in total expense of $4.2 million, a decrease in net otherincome and gain (loss) of $19.1 million and a decrease in net income (loss) of$3.8 million. There was no effect on the income (loss) attributable to DFR as aresult of the adoption of the amendments to ASC Topic 810.

 

In January 2010, theFASB issued ASU No. 2010-06—*Fair ValueMeasurements and Disclosure (“ASC Topic 820”)—Improving Disclosures about FairValue Measurements* (“ASU 2010-06”). ASU 2010-06 amends ASC Topic 820to add new requirements for disclosures about transfers into and out ofLevels 1 and 2 and separate disclosures about purchases, sales, issuancesand settlements relating to Level 3 measurements. ASU 2010-06 alsoclarifies existing fair value disclosures about the level of disaggregation andabout inputs and valuation techniques used to measure fair value. We adoptedASU 2010-06 and have included the required disclosures, with the exception ofthe requirement to provide disclosure of the Level 3 activity of purchases,sales, issuances and settlements on a gross basis, which will be effective forour interim and annual reporting periods that begin after December 15,2010.

 

**Financial Condition**

 

The following tablesummarizes the carrying value of our investment portfolio by balance sheetclassification as of March 31, 2010 for our Principal Investing andInvestment Management segments:

 
| ** **                                       | ** ** | **Investments at** | ** ** | **Other**       | ** ** | **Loans Held** | ** ** | **Loans Held**     | ** ** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-----------------|------------|----------------|------------|--------------------|------------|------------|
| **Security Description**                         | ** ** | **Fair Value**     | ** ** | **Investments** | ** ** | **For Sale**   | ** ** | **For Investment** | ** ** | **Total**  |
| ** **                                       | ** ** | **(In thousands)** |
| RMBS                                             |       | $                  | 303,258    |            | $          | —         |       | $                  | —     |       | $ | — |   | $ | 303,258 |
| Corporate  leveraged loans:                      |       |               |       |            |       |           |       |               |       |       |
| Loans  held in DFR MM CLO (1)                    |       | —             |       | —          |       | —         |       | 267,156            |       | 267,156    |
| Other  corporate leveraged loans                 |       | —             |       | —          |       | 517            |       | —             |       | 517        |
| Loans  held in DPLC                              |       | 5,265              |       | —          |       | —         |       | —             |       | 5,265      |
| Commercial  real estate loans and securities (2) |       | —             |       | —          |       | —         |       | 9,453              |       | 9,453      |
| Equity  securities                               |       | —             |       | 1,345           |       | —         |       | —             |       | 1,345      |
| Other  investments (3)                           |       | 9,090              |       | —          |       | —         |       | —             |       | 9,090      |
| Total  invested assets                           |       | $                  | 317,613    |            | $          | 1,345          |       | $                  | 517        |       | 276,609 |   | 596,084 |
|                                             |       |               |       |            |       |           |       |               |       |       |
| Allowance  for loan losses                       |       |               |       |            |       |           |       | (12,764)           |       | (12,764)   |
|                                             |       |               |       |            |       |           |       |               |       |       |
|                                             |       |               |       |            |       |           |       | $                  | 263,845    |       | $ | 583,320 |

 

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(1)                                  Loans held inDFR MM CLO classified as loans held for investment are reported grossof a $5.4 million allowance for loan losses as of March 31, 2010.

 

(2)                                  Commercial realestate loans are reported gross of a $7.4 million allowance for loan losses asof March 31, 2010.

 

(3)                                  Otherinvestments includes $4.4 million of investments in the CIP CDOs that areeliminated upon consolidation.

 

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***Residential Mortgage-Backed Securities***

 

For the three months ended March 31,2010, we had net purchases of RMBS of $43.0 million and received RMBSprincipal paydowns of $43.2 million. This activity was partially off-setby a $0.9 million net decrease in the fair value of our RMBS holdings and$1.4 million of realized gains during the first quarter of 2010.Consequently, the fair value of our Agency RMBS and non-Agency RMBS declinedfrom $302.5 million and $2.6 million, respectively, as of December 31,2009 to a fair value of $300.8 million and $2.5 million,respectively, as of March 31, 2010.

 

As of March 31, 2010,our RMBS portfolio had a net amortized cost of 103.3% of its face value. Ourtotal RMBS amortization for the three months ended March 31, 2010 and 2009was $2.3 million and zero, respectively. As of March 31, 2010 and 2009, wehad unamortized net premium of $10.0 million and $0.2 million,respectively, included in the cost basis of our RMBS portfolio. As of March 31,2010 and 2009, the current weighted average life of the portfolio, whichrepresents the average number of years for which each dollar of unpaidprincipal remains outstanding, was 6.4 years and 5.7 years,respectively.

 

Net portfolio duration,which is the difference between the duration of our RMBS portfolio and theduration of our repurchase agreements, adjusted for the effects of our interestrate swap portfolio, was 1.6 based on model-driven modified duration results.However, based on actual price movements observed in the market, we believe theempirical duration is significantly lower. In order to fully assess thepossible impact of a change in interest rates on the RMBS portfolio, one shouldconsider not only the duration, but also the portfolio’s leverage and spreadrisk. Our primary means of measuring and managing spread risk in our RMBSportfolio is to compute and monitor the dollar value of a 1 basis pointchange (the “DV01”) in the option adjusted spread at which our securities tradein relation to similar duration treasury obligations.

 

The following table detailsour RMBS holdings as of March 31, 2010:

 
| ** **                        | ** ** | ** **          | ** ** | ** **      | ** ** | **Weighted  Average** | ** ** |
|-----------------------------------|------------|---------------------|------------|-----------------|------------|-----------------------|------------|
| ** **                        | ** ** | ** **          | ** ** | ** **      | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | **Contractual** | ** ** | **Constant** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Par**             | ** ** | **Estimated**   | ** ** | ** **            | ** ** | **Months  to** | ** ** | **Yield  to** | ** ** | **Maturity** | ** ** | **Prepayment** | ** ** | **Modified** | ** ** |
| **Security  Description**         | ** ** | **Amount**          | ** ** | **Fair  Value** | ** ** | **Coupon**            | ** ** | **Reset  (1)** | ** ** | **Maturity** | ** ** | **(Month/Year)** | ** ** | **Rate  (2)** | ** ** | **Duration  (3)** | ** ** |
| ** **                        | ** ** | **(In  thousands)** | ** ** | ** **      | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **December 31, 2009:**       | ** ** | ** **          | ** ** | ** **      | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Hybrid  Adjustable Rate RMBS:     | ** ** | ** **          | ** ** | ** **      | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Rate  reset in 1 year or less     |       | $                   | 88,471     |            | $          | 91,565                |       | 4.79% |   | 7 |   | 2.1% |   | 06/35 |   | 9.1% |   | 1.3% |   |
| Rate  reset in 1 to 3 years       |       | 127,113             |       | 133,255         |       | 5.16%                 |       | 24 |   | 2.4% |   | 03/36 |   | 10.9% |   | 1.7% |   |
| Rate  reset in 3 to 5 years       |       | 17,355              |       | 18,414          |       | 5.23%                 |       | 52 |   | 2.5% |   | 03/35 |   | 15.5% |   | 1.7% |   |
| Rate  reset in 5 to 7 years       |       | 60,453              |       | 51,742          |       | 5.11%                 |       | 65 |   | 2.5% |   | 04/37 |   | 18.3% |   | 1.7% |   |
| Rate  reset in 7 to 10 years      |       | 4,589               |       | 4,822           |       | 5.11%                 |       | 96 |   | n/m |   | 04/38 |   | 16.2% |   | 3.0% |   |
| Fixed  Rate RMBS:                 |       |                |       |            |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| 30  year                          |       | 9,332               |       | 3,460           |       | 6.09%                 |       | n/a |   | n/m |   | 12/34 |   | 23.7% |   | 2.7% |   |
| Total  hybrid and fixed rate RMBS |       | $                   | 307,313    |            | $          | 303,258               |       |   |   |   |   |   |   |   |   |   |   |   |   |

 

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(1)                                  Representsnumber of months before conversion to floating rate.

 

(2)                                  Constantprepayment rate refers to the expected average annualized percentage rate ofprincipal prepayments over the remaining life of the security. The valuesrepresented in this table are estimates only and the results of a third partyfinancial model.

 

(3)                                  Modifiedduration represents the approximate percentage change in fair value per 100basis point change in interest rates.

 

                                              n/a—notapplicable

 

                                              n/m—notmeaningful

 

Actual maturities of RMBSare generally shorter than stated contractual maturities, as they are affectedby the contractual lives of the underlying mortgages, normal monthlyamortization of principal and voluntary prepayments of principal. The statedcontractual final maturity of the mortgage loans underlying our portfolio ofRMBS ranges up to 30 years from date of issuance, but the expected maturityis subject to change based on the actual and estimated prepayments of theunderlying loans.

 

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The constant prepayment rate(“CPR”) attempts to predict the average annualized percentage rate of principalprepayments over the remaining life of the security. As interest rates rise,the rate of refinancing typically declines, which we believe may result inlower rates of prepayment and, as a result, a lower portfolio CPR. CPR also maybe influenced by defaults in the mortgage loans underlying the RMBS that we hold.The Agencies that guarantee timely payment of principal and interest to RMBSholders may periodically choose to buy such delinquent mortgage loans from thepool by repaying the outstanding principal balance on the loan therebyincreasing unscheduled repayments of principal and increasing CPR. Therefore,during periods of high delinquencies and defaults in the mortgages underlyingour RMBS, we would also expect increases in prepayments and CPR. Furthermore,during the first quarter of 2010, Fannie Mae and Freddie Mac announced andbegan to carry out plans to buy “substantially” all mortgages held in RMBSpools issued under their respective programs that are delinquent by120 days or more. This action had the effect of increasing the near-termCPR on our RMBS securities.

 

As of March 31, 2010,the mortgages underlying our hybrid adjustable-rate RMBS had fixed interestrates for a weighted average period of approximately 29 months after whichtime the interest rates reset and become adjustable. The average length of timeuntil contractual maturity of those mortgages was approximately 26 yearsfrom date of issuance as of March 31, 2010.

 

After the reset date,interest rates on our hybrid adjustable-rate RMBS float based on spreads overvarious London Interbank Offered Rate (“LIBOR”) and U.S. Treasury indices.These interest rates are subject to caps that limit the amount the applicableinterest rate can increase during any year, known as an annual cap, and throughthe maturity of the applicable security, known as a lifetime cap. As of March 31,2010, the weighted average lifetime rate cap for the portfolio was 10.3%, theweighted average maximum increase in the first year that the rates areadjustable (“initial cap”) was 4.9%, and the weighted average maximum annualincrease for years subsequent to the first year was 2.0%.

 

***Loans***

 

The following summarizes ourloan portfolio, by loan classification, for our Principal Investing segment asof March 31, 2010:

 
| ** **                        | ** ** | **Carrying Value** |
|-----------------------------------|------------|--------------------|
| ** **                        | ** ** | **Investments at** | ** ** | **Loans Held** | ** ** | **Loans Held** | ** ** | ** ** |
| **Type of Loan**                  | ** ** | **Fair Value**     | ** ** | **for Sale (1)** | ** ** | **for Investment** | ** ** | **Total** |
| ** **                        | ** ** | **(In thousands)** |
| Corporate  leveraged loans:       |       |               |   |   |   |   |   |   |
| Loans  held in DFR MM CLO (2)     |       | $                  | — |   | $ | — |   | $ | 267,156 |   | $ | 267,156 |
| Other  corporate leveraged loans  |       | —             |   | 517 |   | — |   | 517 |
| Loans held in  DPLC (3)           |       | 5,265              |   | — |   | — |   | 5,265 |
| Commercial real  estate loans (4) |       | —             |   | — |   | 9,453 |   | 9,453 |
|                              |       | $                  | 5,265 |   | $ | 517 |   | 276,609 |   | 282,391 |
| Allowance for  loan losses        |       |               |   |   |   | (12,764) |   | (12,764) |
|                              |       |               |   |   |   | $ | 263,845 |   | $ | 269,627 |

 

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(1)                                  Carrying valueof loans held for sale is lower of cost or estimated fair value.

 

(2)                                  Loans held inDFR MM CLO classified as loans held for investment are reported grossof $5.4 million allowance for loan losses as of March 31, 2010.

 

(3)                                  Commercial realestate loans are reported gross of $7.4 million allowance for loan losses as ofMarch 31, 2010.

 

(4)                                  Loans held inDPLC are syndicated bank loans. We elected to record these loans at fair valuein accordance with ASC Topic 825.

 

The following summarizes ourallowances for loan losses by loan classification as of March 31, 2010:

 

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|                          |   | **Number**   | ** ** | **Par**            | ** ** | **Allowance**       |
|-------------------------------|--------|--------------|------------|--------------------|------------|---------------------|
| **Type of Loan**              |   | **of Loans** | ** ** | **Value**          | ** ** | **for Loan Losses** |
|                          |   | ** **   | ** ** | **(In thousands)** |
|                          |   | ** **   | ** ** | ** **         | ** ** | ** **          |
| Loans held in  DFR MM CLO     |   | 4            |       | $                  | 9,798      |                | $ | 5,356 |
| Commercial real  estate loans |   | 3            |       | 8,058              |       | 7,408               |
| Total                         |   | 7            |       | $                  | 17,856     |                | $ | 12,764 |

 

We did not recognize$0.8 million and $0.7 million of interest income earned, but not yetreceived, on loans held for investment and loans held for sale, respectively,for the three months ended March 31, 2010.

 

***Loans Held in DFR MM CLO***

 

DFR MM CLO is aVIE under ASC Topic 810. We have determined that we are the primarybeneficiary of the VIE, causing us to consolidate the entity. We own 100% ofthe equity interests, issued as subordinated notes and preference shares, inDFR MM CLO, which we purchased for $50.0 million. DFR MM CLO isincluded in our Principal Investing segment. We also purchased all of the “BBB/Baa2”rated notes of DFR MM CLO for $19.0 million. As of March 31,2010, DFR MM CLO had $278.4 million of investments in loansoutstanding, with a carrying value of $267.2 million, which is included inloans on the consolidated balance sheet, reduced by an allowance for loanlosses of $5.3 million. As of March 31, 2010, DFR MM CLOhad restricted cash and cash equivalents of $14.7 million, which aregenerally utilized to purchase additional loans and pay distributions to debtand equity holders, and $217.3 million of notes payable to third partyinvestors, which is included in our long term debt. The weighted average couponon the loan portfolio was 6.44%, and the weighted average contractual maturityof the loan portfolio was 3.9 years, as of March 31, 2010.DFR MM CLO is a bankruptcy remote entity, and, although weconsolidate 100% of the assets and liabilities of DFR MM CLO, our maximumexposure to loss on our investment in DFR MM CLO is limited to ourinitial investment of $69.0 million. As of March 31, 2010, we have receiveddistributions from DFR MM CLO equal to $30.7 million since itsinception.

 

The following tablesummarizes the carrying value of the DFR MM CLO loan portfolio:

 
| ** **                 | ** ** | **March 31,** |
|----------------------------|------------|--------------------|
| **Type of Loan**           | ** ** | **2010**           |
| ** **                 | ** ** | **(In thousands)** |
| First lien  secured (1)    |       | $                  | 124,029 |
| Second lien  secured (2)   |       | 129,441            |
| Mezzanine                  |       | 13,686             |
| ** **                 |       | 267,156            |
| Allowance for  loan losses |       | (5,331)            |
| ** **                 |       | $                  | 261,825 |

 

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(1)                                  Presented grossof a $1.2 million allowance for loan losses as of March 31, 2010.

 

(2)                                  Presented grossof a $4.1 million allowance for loan losses as of March 31, 2010.

 

***Loans Held in DPLC***

 

DPLC is a bankruptcy remoteentity that we have determined we were required to consolidate pursuant to ASCTopic 810 as a result of our controlling interest therein as of March 31,2010. On April 15, 2010, we withdrew our entire capital account fromDPLC.    As of March 31, 2010, DPLChad investments in $5.6 million of loans, with an estimated fair value of$5.3 million, which are included in investments at fair value on theconsolidated balance sheet. We elected to record all investments held in DPLCat fair value in accordance with ASC Topic 825. As of March 31, 2010,DPLC had $12.7 million of restricted cash and cash equivalents, of which$12.4 million was paid to investors on April 15, 2010, and the remainingis available for distributions and to pay expenses. As of March 31, 2010,weighted average coupon on the DPLC loan portfolio was 4.29%, and the weightedaverage contractual maturity of the loan portfolio was 4.0 years.

 

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***Other Corporate Leveraged Loans***

 

We had other corporateleveraged loans totaling $0.5 million classified as loans held for sale onthe consolidated balance sheet as of March 31, 2010.  The weighted average coupon on the othercorporate leveraged loans as of March 31, 2010 was zero as all of theseloans were on non-accrual status.

 

***Commercial Real Estate Loans***

 

We held four commercial realestate loans with a gross carrying value of $9.4 million as of March 31,2010.  As of March 31, 2010, anallowance for loan losses of $7.4 million was recorded related to theseloans. These loans are classified as held for investment on our consolidatedbalance sheet.

 

***Derivatives and Hedging***

 

The following tablesummarizes the derivative instruments in our Principal Investing segment as of March 31,2010:

 
| ** **                       | ** ** | ** ** | ** ** | **Notional**       | ** ** | ** ** | ** ** | ** **      | ** ** | **Estimated Net** |
|----------------------------------|------------|------------|------------|--------------------|------------|------------|------------|-----------------|------------|-------------------|
| ** **                       | ** ** | **Count**  | ** ** | **Amount**         | ** ** | **Assets** | ** ** | **Liabilities** | ** ** | **Fair Value**    |
| ** **                       | ** ** | ** ** | ** ** | **(In thousands)** |
| Interest  rate swaps             |       | 1          |       | $                  | 10,000     |       | $          | —          |       | $                 | (199) |   | $ | (199) |
| Interest  rate cap in DFR MM CLO |       | 1          |       | 40,000             |       | —     |       | (37)            |       | (37)              |
| Warrants                         |       | 3          |       | n/a                |       | 26         |       | —          |       | 26                |
|                             |       | 5          |       | $                  | 50,000     |       | $          | 26              |       | $                 | (236) |   | $ | (210) |

 

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n/a—not applicable

 

***Warrants***

 

On April 14, 2009, weannounced the formation of DPLC, our investment venture with Pegasus. Inconnection with the formation of DPLC, we issued to Pegasus Deerfield, anaffiliate of Pegasus, (i) a five-year warrant to purchase 2,500,000 sharesof our common stock at an exercise price of $4.25 per share (“Warrant A”) and (ii) afive-year warrant to purchase 500,000 shares of our common stock at an exerciseprice of $10.00 per share (“Warrant B” and, together with Warrant A, the “Warrants”).

 

On March 21, 2010, weentered into the Termination Agreement with the Pegasus Parties, the DeerfieldParties and Jonathan Trutter, our CEO, pursuant to which the Pegasus Partieswaived certain rights with respect to the issuance of the Stock Considerationand the issuance of the Conversion Shares. In addition, the Deerfield Partiesand the Pegasus Parties agreed to terminate or amend certain provisions ofagreements related to DPLC and cancel the Warrants.

 

We also agreed to grantcertain of the Pegasus Parties and their affiliates the DPLC RestructuringWarrants, which are fully vested warrants to purchase 250,000 shares of ourcompany’s common stock at an exercise price of $4.25 per share. For the threemonths ended March 31, 2010, we recognized $0.5 million of warrant expenserelated to the DPLC Restructuring Warrants in other general and administrativeexpense in the condensed consolidated statement of operations.

 

***Consolidated InvestmentProducts***

 

Investmentsin the Consolidated Investment Products segment include loans, corporate bondsand other investments recorded at fair value. The investments of the Consolidated Investment Products segment are heldsolely to satisfy the obligations of the CIP CDOs.  We have no right to the benefits from, nor dowe bear the risks associated with, the assets held by the CIP CDOs beyond ourminimal direct investments in, and management fees generated from, the CIPCDOs.

 

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**Results of Operations**

 

The following section provides a comparative discussion of ourconsolidated results of operations as of and for the three months ended March 31,2010 and March 31, 2009.

 

***Summary***

 

The following table summarizes selected historical consolidated financialinformation:

 
| ** **                                                                     | ** ** | **Three months ended March 31,**        |
|--------------------------------------------------------------------------------|------------|----------------------------------------------|
| ** **                                                                     | ** ** | **2010**                                     | ** ** | **2009** |
| ** **                                                                     | ** ** | **(In millions, except for per share data)** |
| ** **                                                                     | ** ** | ** **                                   | ** ** | ** ** |
| **Consolidated Statements of Operations Data:**                                |       |                                         |   |   |
| Net  revenues                                                                  |       | $                                            | 22.5 |   | $ | 9.4 |
| Total  expenses                                                                |       | $                                            | 14.1 |   | $ | 8.3 |
| Net  other income and (loss) gain                                              |       | $                                            | (11.7) |   | $ | 10.5 |
| Net  income (loss)                                                             |       | $                                            | (3.3) |   | $ | 11.5 |
| Net  gain attributable to noncontrolling interest                              |       | $                                            | 3.2 |   | $ | — |
| Net  income (loss) attributable to Deerfield Capital Corp.                     |       | $                                            | (0.1) |   | $ | 11.5 |
| Net  income (loss) attributable to Deerfield Capital Corp. per share - diluted |       | $                                            | (0.02) |   | $ | 1.72 |
| Core  earnings (1)                                                             |       | $                                            | 4.5 |   | $ | 5.0 |
| Core  earnings per share - diluted (2)                                         |       | $                                            | 0.66 |   | $ | 0.75 |

 
|                                        | ** ** | **As  of March 31,**                          |
|---------------------------------------------|------------|-----------------------------------------------|
|                                        | ** ** | **2010**                                      | ** ** | **2009** |
|                                        | ** ** | **(In  millions, except for per share data)** |
| ** **                                  |       |                                          |   |   |   |   |
| **Consolidated Balance Sheet Data:**        |       |                                          |   |   |   |   |
| Residential  mortgage-backed securities     |       | $                                             | 303.3 |   | $ | 338.7 |
| Assets  in Consolidated Investment Products |       | $                                             | 2,383.3 |   | $ | — |
| Total  assets                               |       | $                                             | 3,096.2 |   | $ | 986.3 |
| Repurchase  agreements                      |       | $                                             | 277.6 |   | $ | 318.6 |
| Long  term debt:                            |       |                                          |   |   |
| Recourse:                                   |       |                                          |   |   |
| Trust  preferred securities                 |       | $                                             | 25.8 |   | $ | 123.7 |
| Junior  subordinated debt                   |       | $                                             | 95.0 |   | $ | — |
| Series A  and Series B Notes      |       | $                                             | 72.4 |   | $ | 71.9 |
| Non-Recourse:                               |       |                                          |   |   |
| DFR  MM CLO                                 |       | $                                             | 217.3 |   | $ | 231.0 |
| Wachovia  Facility                          |       | $                                             | — |   | $ | 12.0 |
| Market  Square CLO                          |       | $                                             | — |   | $ | 276.0 |
| Consolidated  Investment Products           |       | $                                             | 2,069.4 |   | $ | — |
| Total  stockholders’ equity (deficit)  |       | $                                             | 234.2 |   | $ | (70.5) |
|                                        |       |                                          |   |   |
| **AUM:**                                    |       |                                          |   |   |
| Investment  Management segment (3) (4) |       | $                                             | 8,873.6 |   | $ | 10,321.5 |
| Principal  Investing segment (4) (5)   |       | $                                             | 581.5 |   | $ | 839.7 |

 

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(1)                                  Core earningsrepresents a non-GAAP financial measure. Please see the *“Reconciliationof Non-GAAP Financial Measures”* below for a reconciliation betweenthe comparable GAAP measure and a discussion of the importance placed on thismeasure by management.

 

(2)                                  We utilized thefully-diluted share number of 6,769,848 in the computation of the diluted coreearnings per share for the three months ended March 31, 2010, whichincludes the dilutive impact of the DPLC Restructuring Warrants.

 

(3)                                  AUM for ourInvestment Management segment includes CDO AUM numbers, which generally reflectthe aggregate principal or notional balance of the collateral and, in somecases, the cash balances held by the CDOs as of the date

 

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of the last trustee report received for each CDO prior to the relevantmeasurement date. The AUM for our Euro-denominated CDOs has been converted intoU.S. dollars using the appropriate spot rate of exchange. AUM for ourInvestment Management segment also includes AUM for our separately managedaccounts, which, in certain cases, is a multiple of the capital actuallyinvested in such account. Management fees for these accounts are paid on thishigher AUM amount. Included in Investment Management segment AUM is$279.7 million and $293.8 million related to DFR MM CLO for April 1,2010 and 2009, respectively. DCM manages this CLO, but is not contractuallyentitled to receive any management fees from DFR MM CLO for so long as 100% ofits preference shares are held by DC LLC or an affiliate thereof. Included inInvestment Management segment AUM is $296.5 million related to Market SquareCLO for April 1, 2009. DCM manages this CLO, but was not contractuallyentitled to receive any management fees therefrom prior to the sale of ourMarket Square CLO preference shares on June 30, 2009.

 

(4)                                  AUM for DFR MMCLO is included in both Investment Management segment AUM and PrincipalInvesting segment AUM for April 1, 2010 and 2009.  AUM for DPLC is included in both InvestmentManagement segment AUM and Principal Investing segment for AUM for April 1,2010. AUM for Market Square CLO is included in both Investment Managementsegment AUM and Principal Investing segment AUM for April 1, 2009.

 

(5)                                  AUM for thePrincipal Investing segment is reflected net of allowance for loan losses of$12.8 million and $22.2 million as of March 31, 2010 and March 31,2009, respectively.

 

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**Reconciliation of Non-GAAP Financial Measures**

 

We believe that core earnings, a non-GAAP financial measure, is auseful metric for evaluating and analyzing our performance. The calculation ofcore earnings, which we use to compare our own financial results from period toperiod, eliminates the impact of certain non-cash items, special charges andincome tax. The core earnings provided herein may not be comparable to similarmeasures presented by other companies as it is a non-GAAP financial measure andmay therefore be defined differently by other companies. Core earnings includesthe earnings from DFR MM CLO for both the three months ended March 31,2010 and March 31, 2009, and from Market Square CLO for the three monthsended March 31, 2009, which was a consolidated VIE until we sold all ofour preference shares in Market Square CLO and deconsolidated that VIE as of June 30,2009. Core earnings is not necessarily indicative of cash flows received fromthese VIEs.

 

**Core Earnings**

 

The table below provides a reconciliation between net income (loss) andcore earnings:

 
|                                                     |   | **Three months ended March 31,**                  |
|----------------------------------------------------------|--------|--------------------------------------------------------|
|                                                     |   | **2010**                                               | ** ** | **2009** |
|                                                     |   | **(In thousands, except share and per share amounts)** |
|                                                     |   |                                                   |   |   |
| Net  income (loss)                                       |   | $                                                      | (3,300) |   | $ | 11,539 |
| Add  back (subtract):                                    |   |                                                   |   |   |
| Provision  for loan losses                               |   | 4,186                                                  |   | 2,107 |
| Depreciation  and amortization                           |   | 5,738                                                  |   | 1,635 |
| Impairment  of intangible assets                         |   | 168                                                    |   | — |
| Net  other income and (gain) loss                        |   | 11,690                                                 |   | (10,469) |
| Income  tax expense                                      |   | —                                                 |   | 18 |
| Noncontrolling  interest core earnings (1)               |   | (15,575)                                               |   | — |
| Cost  savings initiatives                                |   | —                                                 |   | 197 |
| Warrant  expense (2)                                     |   | 529                                                    |   | — |
| Proposed  strategic transaction costs (2)                |   | 1,019                                                  |   | — |
| Core  earnings                                           |   | $                                                      | 4,455 |   | $ | 5,027 |
|                                                     |   |                                                   |   |   |
| Core  earnings per share - diluted                       |   | $                                                      | 0.66 |   | $ | 0.75 |
| Weighted-average  number of shares outstanding - diluted |   | 6,769,848                                              |   | 6,702,329 |

 

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(1)          Noncontrolling interest coreearnings is comprised of (i) the portion of net interest income andexpenses of DPLC that are attributable to third party investors in DPLC,calculated using each investor’s ownership percentage in DPLC during themeasurement period, and (ii) the portion of net interest income andexpenses of the CIP CDOs that are consolidated due to the new ConsolidatedInvestment Products segment that are attributable to third party investors inthe CIP CDOs.

 

(2)          We utilized thefully-diluted share number of 6,769,848 in the computation of the diluted coreearnings per share for the three months ended March 31, 2010, whichincludes the dilutive impact of the DPLC Restructuring Warrants.

 

**ExecutiveSummary of Results of Operations**

 

When we analyzeour financial results, we focus on the combined results of the InvestmentManagement and Principal Investing segments (“DFR Operations”). While we arerequired to include the Consolidated Investment Products segment in ourconsolidated GAAP results, this segment does not have any economic impact onour operations.

 

The ConsolidatedInvestment Products segment includes the results of the CIP CDOs, which, as of January 1,2010, we are required to consolidate in accordance with the amendments to ASCTopic 810 and with respect to which we have elected fair value accounting atthe date of adoption (January 1, 2010). DFR MM CLO is not included in theConsolidated Investment Products segment, but instead is included in thePrincipal Investing segment because we own 100% of its preference shares.  We have not elected fair value accounting forDFR MM CLO. The collateral assets of the CIP CDOs are held solely to satisfythe obligations of the CIP CDOs. We have no right to the benefits from, nor dowe bear the risks associated with, the collateral assets held by the CIP CDOs,beyond our minimal direct investments in, and management fees generated from,the CIP CDOs. If we were to liquidate, the collateral assets of the CIP CDOswould not be available to our general creditors, and as a result, we do notconsider them to be our assets. Additionally, the investors in the CIP CDOshave 

 

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no recourse to thegeneral credit of DFR for the debt issued by the CIP CDOs. We therefore do notconsider this debt to be an obligation of ours. When reviewing and analyzing our financial results, management excludesthe impact of the Consolidated Investment Products segment as this segment doesnot have any economic impact on our operations.

 

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The following table providesa breakdown of our condensed consolidated statements of operations intosegment-based components and reconciles the DFR Operations to GAAP. DFROperations for the three months ended March 31, 2010 is comparable to ourconsolidated GAAP results for prior periods.

 

**DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES**

**COMPONENT CONDENSED STATEMENTS OF OPERATIONS(UNAUDITED)**

 
|                                                                                   |   | **Three months ended March 31, 2010**             |
|----------------------------------------------------------------------------------------|--------|--------------------------------------------------------|
|                                                                                   |   | ** **                                             | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated** | ** ** | ** ** | ** ** | ** ** |
|                                                                                   |   | **Investment**                                         | ** ** | **Principal** | ** ** | ** ** | ** ** | **Investment** | ** ** | ** ** | ** ** | **GAAP** |
|                                                                                   |   | **Management**                                         | ** ** | **Investing** | ** ** | **DFR** | ** ** | **Products** | ** ** | ** ** | ** ** | **Consolidated** |
|                                                                                   |   | **Segment (1)**                                        | ** ** | **Segment (1)** | ** ** | **Operations** | ** ** | **Segment** | ** ** | **Elimination** | ** ** | **DFR** |
|                                                                                   |   | **(In thousands, except share and per share amounts)** |
| **Revenues**                                                                           |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                                                                        |   | $                                                      |  6 |   |   | $ | 7,269 |   |   | $ | 7,275 |   |   | $ | 24,286 |   |   | $ | (59 | ) |   | $ | 31,502 |   |
| Interest expense                                                                       |   | 1,213                                                  |   |   | 1,785 |   |   | 2,998 |   |   | 4,755 |   |   | (59 | ) |   | 7,694 |   |
| Net interest  income                                                                   |   | (1,207                                                 | ) |   | 5,484 |   |   | 4,277 |   |   | 19,531 |   |   | — |   |   | 23,808 |   |
| Provision for  loan losses                                                             |   | —                                                 |   |   | 4,186 |   |   | 4,186 |   |   | — |   |   | — |   |   | 4,186 |   |
| Net interest  income (expense) after provision for loan losses                         |   | (1,207                                                 | ) |   | 1,298 |   |   | 91 |   |   | 19,531 |   |   | — |   |   | 19,622 |   |
| Investment  advisory fees                                                              |   | 6,502                                                  |   |   | — |   |   | 6,502 |   |   | — |   |   | (3,606 | ) |   | 2,896 |   |
| Total net  revenues                                                                    |   | 5,295                                                  |   |   | 1,298 |   |   | 6,593 |   |   | 19,531 |   |   | (3,606 | ) |   | 22,518 |   |
|                                                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Expenses**                                                                           |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Compensation and  benefits                                                             |   | 2,841                                                  |   |   | — |   |   | 2,841 |   |   | — |   |   | — |   |   | 2,841 |   |
| Professional  services                                                                 |   | 153                                                    |   |   | 1,772 |   |   | 1,925 |   |   | 363 |   |   | — |   |   | 2,288 |   |
| Insurance expense                                                                      |   | 91                                                     |   |   | 601 |   |   | 692 |   |   | — |   |   | — |   |   | 692 |   |
| Other general and  administrative expenses                                             |   | 414                                                    |   |   | 1,239 |   |   | 1,653 |   |   | 258 |   |   | — |   |   | 1,911 |   |
| Depreciation and  amortization                                                         |   | 5,738                                                  |   |   | — |   |   | 5,738 |   |   | — |   |   | — |   |   | 5,738 |   |
| Occupancy                                                                              |   | 490                                                    |   |   | — |   |   | 490 |   |   | — |   |   | — |   |   | 490 |   |
| Management and  incentive fee expense to related party                                 |   | —                                                 |   |   | — |   |   | — |   |   | 3,606 |   |   | (3,606 | ) |   | — |   |
| Impairment of  intangible assets                                                       |   | 168                                                    |   |   | — |   |   | 168 |   |   | — |   |   | — |   |   | 168 |   |
| Total expenses                                                                         |   | 9,895                                                  |   |   | 3,612 |   |   | 13,507 |   |   | 4,227 |   |   | (3,606 | ) |   | 14,128 |   |
|                                                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Other  Income and Gain (Loss)**                                                      |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net gain (loss)  on investments at fair value                                          |   | 1,172                                                  |   |   | 3,349 |   |   | 4,521 |   |   | 69,991 |   |   | (1,480 | ) |   | 73,032 |   |
| Net gain (loss)  on liabilities at fair value                                          |   | —                                                 |   |   | — |   |   | — |   |   | (89,335 | ) |   | 1,480 |   |   | (87,855 | ) |
| Net gain on loans                                                                      |   | —                                                 |   |   | 2,754 |   |   | 2,754 |   |   | — |   |   | — |   |   | 2,754 |   |
| Net loss on  derivatives                                                               |   | —                                                 |   |   | (55 | ) |   | (55 | ) |   | (612 | ) |   | — |   |   | (667 | ) |
| Dividend income  and other net gain (loss)                                             |   | (20                                                    | ) |   | 258 |   |   | 238 |   |   | 808 |   |   | — |   |   | 1,046 |   |
| Net other income  and gain (loss)                                                      |   | 1,152                                                  |   |   | 6,306 |   |   | 7,458 |   |   | (19,148 | ) |   | — |   |   | (11,690 | ) |
| Income (loss)  before income tax (benefit) expense                                     |   | (3,448                                                 | ) |   | 3,992 |   |   | 544 |   |   | (3,844 | ) |   | — |   |   | (3,300 | ) |
| Income tax  expense                                                                    |   | —                                                 |   |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |
| ** **                                                                             |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net  income (loss)**                                                                 |   | (3,448                                                 | ) |   | 3,992 |   |   | 544 |   |   | (3,844 | ) |   | — |   |   | (3,300 | ) |
| Net (income) loss  attributable to noncontrolling interest                             |   | —                                                 |   |   | (681 | ) |   | (681 | ) |   | 3,844 |   |   | — |   |   | 3,163 |   |
| **Net  income (loss) attributable to Deerfield Capital Corp.**                         |   | $                                                      |  (3,448 | ) |   | $ | 3,311 |   |   | $ | (137 | ) |   | $ | — |   |   | $ | — |   |   | $ | (137 | ) |
| ** **                                                                             |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net  income (loss) attributable to Deerfield Capital Corp .****per  share - basic**  |   | $                                                      |  (0.51 | ) |   | $ | 0.49 |   |   | $ | (0.02 | ) |   |   |   |   |   |   |   | $ | (0.02 | ) |
| **Net  income (loss) attributable to Deerfield Capital Corp.****per  share - diluted** |   | $                                                      |  (0.51 | ) |   | $ | 0.49 |   |   | $ | (0.02 | ) |   |   |   |   |   |   |   | $ | (0.02 | ) |
|                                                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| WEIGHTED-AVERAGE  NUMBER OF SHARES OUTSTANDING - BASIC                                 |   | 6,763,098                                              |   |   | 6,763,098 |   |   | 6,763,098 |   |   |   |   |   |   |   |   | 6,763,098 |   |
| WEIGHTED-AVERAGE  NUMBER OF SHARES OUTSTANDING - DILUTED                               |   | 6,763,098                                              |   |   | 6,763,098 |   |   | 6,763,098 |   |   |   |   |   |   |   |   | 6,763,098 |   |
|                                                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Reconciliation  of net income (loss) and core earnings:**                            |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                             |   | $                                                      |  (3,448 | ) |   | $ | 3,992 |   |   | $ | 544 |   |   | $ | (3,844 | ) |   | $ | — |   |   | $ | (3,300 | ) |
| Adjusting items:                                                                       |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision for  loan losses                                                             |   | —                                                 |   |   | 4,186 |   |   | 4,186 |   |   | — |   |   | — |   |   | 4,186 |   |
| Depreciation and  amortization                                                         |   | 5,738                                                  |   |   | — |   |   | 5,738 |   |   | — |   |   | — |   |   | 5,738 |   |
| Impairment of  intangible assets                                                       |   | 168                                                    |   |   | — |   |   | 168 |   |   | — |   |   | — |   |   | 168 |   |
| Net other income  and gain (loss)                                                      |   | (1,152                                                 | ) |   | (6,306 | ) |   | (7,458 | ) |   | 19,148 |   |   | — |   |   | 11,690 |   |
| Noncontrolling  interest core earnings                                                 |   | —                                                 |   |   | (271 | ) |   | (271 | ) |   | (15,304 | ) |   |   |   |   | (15,575 | ) |
| Warrant expense                                                                        |   | —                                                 |   |   | 529 |   |   | 529 |   |   | — |   |   | — |   |   | 529 |   |
| Proposed  strategic transaction costs                                                  |   | 35                                                     |   |   | 984 |   |   | 1,019 |   |   | — |   |   | — |   |   | 1,019 |   |
| **Core  Earnings**                                                                     |   | $                                                      |  1,341 |   |   | $ | 3,114 |   |   | $ | 4,455 |   |   | $ | — |   |   | $ | — |   |   | $ | 4,455 |   |
|                                                                                   |   |                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Core Earnings per  share - diluted (2)                                                 |   | $                                                      |  0.20 |   |   | $ | 0.46 |   |   | $ | 0.66 |   |   |   |   |   |   |   |   | $ | 0.66 |   |

 

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(1)          Excludes the $0.7 million of intercompanyinvestment advisory fees revenues for the Investment Management segment andcorresponding intercompany Management and incentive fee expense for thePrincipal Investing segment related to the management agreement between the twosegments.

 

(2)          Warrant expenseand proposed strategic transactions costs are related to the DPLC RestructuringWarrants and the Acquisition.

 

During the three monthsended March 31, 2010, we recorded net loss attributable to DFR of$0.1 million, as compared to net income of $11.5 million for the sameperiod in 2009. Although core earnings, calculated in the table above, declinedduring the three months ended March 31, 2010 as compared to the threemonths ended March 31, 2009, it remained positive at $4.5 million forthe three months ended March 31, 2010.

 

During the three monthsended March 31, 2010, DFR Operations experienced a decrease of$2.8 million in net revenues as compared to the three months ended March 31,2009.  This decrease was the result of a$2.5 million decrease in net interest income and a $2.1 million increase in theprovision for loan losses which were partially offset by a $1.8 millionincrease in investment advisory fees.

 

The $2.5 million declinein net interest income as compared to 2009 is a result of a $1.4 milliondecrease related to the deconsolidation of Market Square CLO during the secondquarter of 2009 and a $2.6 million decrease related to accelerated amortizationon certain of our RMBS holdings that were purchased at a premium and theAgencies redeemed at par during the first quarter of 2010.  These declines were partially offset byimprovements in the net interest income earned from our DFR MM CLO and assetsheld in DPLC, which, in the aggregate, contributed a $0.9 million increase tonet interest income.  A reduction in the interestrate environment and, to a lesser extent, a decrease in our long term debtoutstanding contributed an additional $0.6 million of savings.

 

Our investment advisoryfees increased by $1.8 million for the three months ended March 31, 2010as compared to the three months ended March 31, 2009.  The increase in investment advisory fees isprimarily attributable to the receipt of previously deferred subordinatedmanagement fees from certain of the CDOs in our Investment Management segmentduring 2010.

 

During the three monthsended March 31, 2010, expenses increased by $5.2 million as comparedto the three months ended March 31, 2009. This increase of $5.2 million was primarily driven by a $4.1 millionincrease in fixed asset depreciation and amortization due to an acceleration ofexpense in connection with abandoning the fixed assets associated with our oldlease, a $1.1 million increase in professional service fees primarily due tothe proposed strategic transactions and a $0.7 million increase in general andadministrative expenses, which is primarily composed of a $0.5 million and $0.2million increase in expenses related to the DPLC Restructuring Warrants andincreased board of directors compensation relating to the proposed strategictransactions, respectively. This increase in expenses for the three monthsended March 31, 2010 as compared to 2009 is partially offset by a $0.6million decrease in compensation and benefits expense.

 

During the three monthsended March 31, 2010, net other income and gain (loss) declined by$3.0 million as compared to the three months ended March 31, 2009primarily as a result of decreased gains on our loan portfolio.

 

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**Results of Operations by Segment**

 

Managementevaluates the performance of our business based on segment results. Thefollowing table presents the results of operations by segment:

 
| ** **                    | ** ** | **Three months ended March 31, 2010** |
|-------------------------------|------------|--------------------------------------------|
| ** **                    | ** ** | **Investment  Management**                 | ** ** | **Principal  Investing** | ** ** | **DFR  Operations** | ** ** | **Consolidated  Investment  Products** | ** ** | **Eliminations** | ** ** | **Consolidated** |
| ** **                    | ** ** | **(In thousands)**                         |
| Net revenues                  |       | $                                          | 5,295 |   | $ | 1,298 |   | $ | 6,593 |   | $ | 19,531 |   | $ | (3,606 | ) | (1) | $ | 22,518 |   |
| Expenses                      |       | (9,895)                                    |   | (3,612) |   | (13,507) |   | (4,227) |   | 3,606 |   | (1) | (14,128 | ) |
| Other income and  gain (loss) |       | 1,152                                      |   | 6,306 |   | 7,458 |   | (19,148) |   | — |   |   | (11,690 | ) |
| Income tax  expense           |       | —                                     |   | — |   | — |   | — |   | — |   |   | — |   |
| Net income  (loss)            |       | $                                          | (3,448) |   | $ | 3,992 |   | $ | 544 |   | $ | (3,844) |   | $ | — |   |   | $ | (3,300 | ) |
|                          |       |                                       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                    | ** ** | **Three months ended March 31, 2009** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Investment  Management**                 | ** ** | **Principal  Investing** | ** ** | **Consolidated** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **(In thousands)**                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                  |       | $                                          | 3,439 |   | $ | 5,974 |   | $ | 9,413 |   |   |   |   |   |   |   |   |
| Expenses                      |       | (6,540)                                    |   | (1,785) |   | (8,325) |   |   |   |   |   |   |   |   |
| Other income and  gain (loss) |       | (267)                                      |   | 10,736 |   | 10,469 |   |   |   |   |   |   |   |   |
| Income tax  expense           |       | (18)                                       |   | — |   | (18) |   |   |   |   |   |   |   |   |
| Net income  (loss)            |       | $                                          | (3,386) |   | $ | 14,925 |   | $ | 11,539 |   |   |   |   |   |   |   |   |

 

----

(1)          Representsinternal fees charged to the Consolidated Investment Products segment by theInvestment Management segment based on the CIP CDO management agreements.

 

OurPrincipal Investing segment results of operations include the financial resultsof DFR MM CLO for the three months ended March 31, 2010 and March 31,2009 and the financial results of DPLC for the three months ended March 31,2010. The Principal Investing segment results of operations also include thefinancial results of Market Square CLO for the three months ended March 31,2009. On June 30, 2009, we sold all of our preference shares in MarketSquare CLO to an unrelated third party in exchange for an upfront payment and adelayed purchase price in the form of a right to receive a portion of thefuture distributions, if any, on the preference shares. As a result of thesale, we determined we were no longer the primary beneficiary of Market SquareCLO and, therefore, deconsolidated Market Square CLO.

 

**Investment Management Segment**

 

***Revenues***

 

OurInvestment Management segment revenues primarily represent the fee incomeearned for the management of investment accounts for various types of clients.The following table summarizes the Investment Management segment revenues:

 
| ** **                                    | ** ** | **Three months ended March 31,** | ** ** | **Variance** |
|-----------------------------------------------|------------|---------------------------------------|------------|--------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009**     | ** ** | **2010 vs. 2009** |
| ** **                                    | ** ** | **(In thousands)**                    |
| **Investment  Management Segment Revenues**   |       |                                  |       |         |   |   |   |
| Interest income                               |       | $                                     | 6          |         | $ | 46 |   | $ | (40 | ) |
| Interest expense                              |       | 1,213                                 |       | 1,344        |   | (131 | ) |
| Net interest expense                          |       | (1,207)                               |       | (1,298)      |   | 91 |   |
| Investment  advisory fees (1)                 |       | 6,502                                 |       | 4,737        |   | 1,765 |   |
| Total Investment  Management segment revenues |       | $                                     | 5,295      |         | $ | 3,439 |   | $ | 1,856 |   |

 

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(1)                                  Investmentadvisory fees include intercompany investment advisory fees of$3.6 million charged to the Consolidated Investment Products segment forthe three months ended March 31, 2010, which are eliminated uponconsolidation.

 

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*Net Interest Income*

 

Interestincome for the three months ended March 31, 2010 and March 31, 2009is primarily comprised of interest earned on our cash balances. The decrease ininterest income is due to a decrease in principal balance and interest ratesfor our money market account and invested restricted cash.  Interest expense is primarily comprised of$1.2 million and $1.3 million of interest expense on our Series A &B Notes for the three months ended March 31, 2010 and March 31, 2009,respectively. The reduction in interest expense during the three months ended March 31,2010, as compared to the same period in 2009, was the result of decreasedinterest rate environment, partially offset by the 0.50% increase in interestrate spread in accordance with the Series A & B Notes, for thethree months ended March 31, 2010.

 

*Investment Advisory Fees*

 

Forthe three months ended March 31, 2010 and March 31, 2009, investmentadvisory fees were $6.5 million and $4.7 million, respectively, on asegment basis, and $2.9 million and $4.7 million, respectively, on aconsolidated basis due to the $3.6 million of fees earned by the InvestmentManagement segment from the Consolidated Investment Products segment for thethree months ended March 31, 2010, which are eliminated uponconsolidation. Our investment advisory fee revenue during the periods presentedwas generated by our CDOs and our separately managed accounts. The followingdiscussions further analyze and explain changes in our investment advisory feesby type and product.

 

***CDOs***

 

Thefollowing table summarizes the investment advisory fee revenues from our CDOs:

 
| ** **                            | ** ** | **Three months ended March 31,** | ** ** | **Variance** |
|---------------------------------------|------------|---------------------------------------|------------|--------------|
| ** **                            | ** ** | **2010**                              | ** ** | **2009**     | ** ** | **2010 vs. 2009** |
| ** **                            | ** ** | **(In thousands)**                    |
| **Senior  Management Fees:**          | ** ** | ** **                            | ** ** | ** **   | ** ** | ** ** | ** ** |
| CLOs                                  |       | $                                     | 1,654      |         | $ | 1,566 |   | $ | 88 |   |
| ABS                                   |       | 771                                   |       | 1,052        |   | (281 | ) |
| Corporate Bonds                       |       | 390                                   |       | 320          |   | 70 |   |
| **Total  Senior Mangement Fees**      |       | 2,815                                 |       | 2,938        |   | (123 | ) |
|                                  |       |                                  |       |         |   |   |   |
| **Subordinated  Management Fees:**    | ** ** | ** **                            | ** ** | ** **   | ** ** | ** ** | ** ** |
| CLOs                                  |       | 1,396                                 |       | 1,427        |   | (31 | ) |
| ABS                                   |       | 27                                    |       | —       |   | 27 |   |
| Corporate Bonds                       |       | —                                |       | (24)         |   | 24 |   |
| **Total  Subordinate Mangement Fees** |       | 1,423                                 |       | 1,403        |   | 20 |   |
|                                  |       |                                  |       |         |   |   |   |
| **Performance  Fees (1):**            | ** ** | ** **                            | ** ** | ** **   | ** ** | ** ** | ** ** |
| CLOs                                  |       | 2,068                                 | (2)        | —       |   | 2,068 |   |
| ABS                                   |       | —                                |       | —       |   | — |   |
| Corporate Bonds                       |       | —                                |       | 152          |   | (152 | ) |
| **Total  Performance Fees**           |       | 2,068                                 |       | 152          |   | 1,916 |   |
|                                  |       |                                  |       |         |   |   |   |
| **Total  CDO Advisory Fees:**         | ** ** | ** **                            | ** ** | ** **   | ** ** | ** ** | ** ** |
| CLOs                                  |       | 5,118                                 |       | 2,993        |   | 2,125 |   |
| ABS                                   |       | 798                                   |       | 1,052        |   | (254 | ) |
| Corporate Bonds                       |       | 390                                   |       | 448          |   | (58 | ) |
| **Total  CDO Advisory Fees**          |       | $                                     | 6,306      |         | $ | 4,493 |   | $ | 1,813 |   |

 

----

(1)           Performance fees aregenerally earned after certain investors’ returns exceed a specified internalrate of return, or IRR. For purposes of this and the following table, and inaccordance with our accounting policies, we also classify any previouslydeferred senior or subordinated management fees that are subsequently paid asperformance fees.

 

(2)           Performance fees on CLOs forthe three months ended March 31, 2010 represent previously deferredsubordinated management fees.

 

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Ourfees differ from account to account, but in general, our fees from CDOs consistof a senior management fee (payable before the interest payable on the debtsecurities issued by the CDO) that ranges from 5 basis points to 20 basispoints annually of the principal balance of the underlying collateral of theCDO, a subordinate management fee (payable after the interest payable on thedebt securities issued by the CDO and certain other expenses) that ranges from5 basis points to 45 basis points annually of the principal balance of theunderlying collateral of the CDO, and, in certain CDOs, performance fees thatare paid after certain investors’ returns exceed an internal rate of return, orIRR hurdle. The performance fees are based on residual cash flows above the IRRhurdle and vary by transaction.

 

Underthe investment management agreements between DCM and the CDOs it manages, thepayment of DCM’s management fees is generally subject to a “waterfall”structure. Pursuant to these “waterfalls,” all or a portion of DCM’ssubordinated management fees may be deferred if the CDOs do not generatesufficient cash flows to pay the required interest on the notes that the CDOshave issued to investors and certain expenses they have incurred. This couldoccur if, for example, the issuers of the collateral underlying the CDOsdefault on or defer payments of principal or interest relating to suchcollateral or the ratings assigned to such collateral are downgraded below aspecified threshold. In addition, all or a portion of DCM’s subordinatedmanagement fees may be deferred if, among other things, overcollateralizationtests and other structural provisions built into the CDOs divert cashflows tothe prepayment of the debt securities issued by the CDOs.

 

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Thefollowing table summarizes the average AUM and effective and contractual feerates of our CDOs for the periods presented:

 
| ** **           | ** ** | **Three months ended March 31, 2010** |
|----------------------|------------|----------------------------------------------------------------|
| ** **           | ** ** | ** **                                                     | ** ** | ** ** | ** ** | **Weighted Average** |
| ** **           | ** ** | ** **                                                     | ** ** | **Effective Rate (1)** | ** ** | **Contractual Rate (2)** |
| ** **           | ** ** | ** **                                                     | ** ** | **Senior** | ** ** | **Subordinated** | ** ** | **Senior** | ** ** | **Subordinated** |
| ** **           | ** ** | **Average AUM (3)**                                  | ** ** | **Management Fee** | ** ** | **Management Fee (4)** | ** ** | **Management Fee** | ** ** | **Management Fee** |
| ** **           | ** ** | **(In thousands)**                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CLOs (5)             |       | $                                                              | 3,693,843 |   | 0.18% |   | 0.38% |   | 0.18% |   | 0.33% |
|                 |       |                                                           |   |   |   |   |   |   |   |   |
| ABS:                 |       |                                                           |   |   |   |   |   |   |   |   |
| High-grade ABS       |       | 2,928,092                                                      |   | 0.05% |   | 0.00% |   | 0.05% |   | 0.06% |
| Other ABS            |       | 1,065,703                                                      |   | 0.15% |   | 0.01% |   | 0.15% |   | 0.23% |
| Total ABS            |       | 3,993,795                                                      |   | 0.08% |   | 0.00% |   | 0.08% |   | 0.10% |
|                 |       |                                                           |   |   |   |   |   |   |   |   |
| Corporate bonds  (6) |       | 732,209                                                        |   | 0.21% |   | 0.00% |   | 0.21% |   | 0.23% |
| Total CDOs           |       | $                                                              | 8,419,847 |   | 0.13% |   | 0.17% |   | 0.13% |   | 0.21% |
|                 |       |                                                           |   |   |   |   |   |   |   |   |   |
| ** **           | ** ** | **Three months ended March 31, 2009** |
| ** **           | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted Average** |
| ** **           | ** ** | ** **                                                     | ** ** | **Effective Rate (1)** | ** ** | **Contractual Rate (2)** |
| ** **           | ** ** | ** **                                                     | ** ** | **Senior** | ** ** | **Subordinated** | ** ** | **Senior** | ** ** | **Subordinated** |
| ** **           | ** ** | **Average AUM (3)**                                  | ** ** | **Management Fee** | ** ** | **Management Fee (4)** | ** ** | **Management Fee** | ** ** | **Management Fee** |
| ** **           | ** ** | **(In thousands)**                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| CLOs (5)             |       | $                                                              | 3,627,386 |   | 0.17% |   | 0.16% |   | 0.18% |   | 0.33% |
|                 |       |                                                           |   |   |   |   |   |   |   |   |
| ABS:                 |       |                                                           |   |   |   |   |   |   |   |   |
| High-grade ABS       |       | 3,364,298                                                      |   | 0.05% |   | 0.00% |   | 0.05% |   | 0.06% |
| Other ABS            |       | 1,679,118                                                      |   | 0.15% |   | 0.00% |   | 0.15% |   | 0.22% |
| Total ABS            |       | 5,043,416                                                      |   | 0.08% |   | 0.00% |   | 0.08% |   | 0.11% |
|                 |       |                                                           |   |   |   |   |   |   |   |   |
| Corporate bonds  (6) |       | 839,050                                                        |   | 0.15% |   | -0.01% |   | 0.21% |   | 0.23% |
| Total CDOs           |       | $                                                              | 9,509,852 |   | 0.12% |   | 0.06% |   | 0.13% |   | 0.20% |
|                      |            |                                                                |  |  |  |  |  |  |  |  |  |  |

 

----

(1)           The effective ratefor the three months ended March 31, 2010 and March 31, 2009 iscalculated by taking management fees earned during the period divided by theaverage AUM. The senior and subordinated management fee effective rates maydiffer from the contractual fee rates for various reasons, including thefollowing: (a) we may have entered into agreements with specific investorspursuant to which a portion of our management fees are paid to those investorsand (b) our senior or subordinated management fees may be deferred as aresult of certain structural provisions built into the documents governing theCDO. In certain circumstances, we may at a later date, subject to certainperformance triggers, be entitled to repayment of the fees paid to investorsdescribed in (a) above. In addition, we may at a later date, subject tothe satisfaction of certain structural provisions, be entitled to payment ofthe deferred fees described in (b) above.

 

(2)           The weightedaverage contractual senior and subordinated management fee rates are obtainedby multiplying the contractual fee rates for each CDO by that CDO’s average AUMand dividing that number by the total average AUM for the relevant asset class.

 

(3)           Average AUM iscalculated as the average of the AUM on the first day of January, February, March andApril.  CDO AUM numbers generally reflectthe aggregate principal or notional balance of the collateral and, in somecases, the cash balance held by the CDO and are as of the date of the lasttrustee report received for each CDO prior to the AUM date, as appropriate. TheAUM for our Euro-denominated CDOs has been converted to U.S. dollars using thespot rate of exchange as of the respective AUM date.

 

(4)           Thesubordinated management fee effective rates include previously deferred subordinatedmanagement fees received during the year and categorized as performance fees.

 

(5)           DFR MM CLO hasbeen excluded from all categories in this table as DCM manages this CLO, but isnot contractually entitled to receive any management fees for DFR MM CLO solong as 100% of the equity is held by DC LLC or an affiliate thereof. Inaddition, Market Square CLO has been excluded from all categories for the threemonths ended March 31, 2009, as DCM manages this CLO but was notcontractually entitled to receive any management fees therefrom prior to thesale of all of our preference shares of Market Square CLO on June 30,2009.

 

(6)           The effectiveand contractual rates for Robeco CDO are calculated based on the fees that weare entitled to receive pursuant to the asset purchase agreement between DCMand Robeco Investment Management, Inc. and are not the total fees paid bythe CDO or the contractual fee rates set forth in the management agreement.

 

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The following tablesummarizes select details of the structure of each of our CDOs:

 
| ** **                         | ** ** | **Closing Date** | ** ** | **April 1, 2010 AUM  (1)** | ** ** | **First Optional  Call Date (2)** | ** ** | **Auction Call  Date (3)** | ** ** | **Termination of  Reinvestment  Period (4)** | ** ** | **Maturity  Year**                         |
|------------------------------------|------------|-----------------------|------------|-------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------|
| ** **                         | ** ** | **Month/Year**        | ** ** | **(In thousands)**                   | ** ** | **Month/Year**                                   | ** ** | ** **                           |
| **CLOs:**                          |       |                  |       |                                      |       |                                             |       |                                 |       |                                                   |       |                                       |
| Rosemont CLO, Ltd.                 |       | 01/02                 |       | $                                         | 132,945    |                                             | 10/05      |                                 | n/a        |                                                   | 01/07      |                                       | 2013 |
| Forest Creek CLO Ltd.              |       | 05/03                 |       | 241,481                                   |       | 07/07                                            |       | n/a                                  |       | 07/08                                                  |       | 2015                                       |
| Long Grove CLO Ltd.                |       | 06/04                 |       | 322,999                                   |       | 08/08                                            |       | n/a                                  |       | 05/10                                                  |       | 2016                                       |
| Market Square CLO Ltd.             |       | 05/05                 |       | 253,746                                   |       | 07/07                                            |       | n/a                                  |       | 04/11                                                  |       | 2017                                       |
| Cumberland II CLO Ltd.             |       | 09/05                 |       | 375,004                                   |       | 02/10                                            |       | n/a                                  |       | 11/11                                                  |       | 2019                                       |
| Marquette Park CLO Ltd.            |       | 12/05                 |       | 284,683                                   |       | 04/10                                            |       | n/a                                  |       | 01/12                                                  |       | 2020                                       |
| Bridgeport CLO Ltd.                |       | 06/06                 |       | 488,983                                   |       | 10/09                                            |       | n/a                                  |       | 07/13                                                  |       | 2020                                       |
| Burr Ridge CLO Plus Ltd.           |       | 12/06                 |       | 283,859                                   |       | 06/12                                            |       | n/a                                  |       | 03/13                                                  |       | 2023                                       |
| Schiller Park CLO Ltd.             |       | 05/07                 |       | 402,440                                   |       | 07/11                                            |       | n/a                                  |       | 04/13                                                  |       | 2021                                       |
| Bridgeport CLO II Ltd.             |       | 06/07                 |       | 495,161                                   |       | 12/10                                            |       | n/a                                  |       | 09/14                                                  |       | 2021                                       |
| DFR Middle Market CLO Ltd. (5)     |       | 07/07                 |       | 279,710                                   |       | 07/10                                            |       | n/a                                  |       | 07/10                                                  |       | 2019                                       |
| Gillespie CLO PLC (6)              |       | 08/07                 |       | 356,204                                   |       | 02/13                                            |       | n/a                                  |       | 08/13                                                  |       | 2023                                       |
| **Total CLOs**                     |       |                  |       | 3,917,215                                 |       |                                             |       |                                 |       |                                                   |       |                                       |
|                               |       |                  |       |                                      |       |                                             |       |                                 |       |                                                   |       |                                       |
| **ABS CDOs:**                      |       |                  |       |                                      |       |                                             |       |                                 |       |                                                   |       |                                       |
| Mid Ocean CBO 2000-1 Ltd.          |       | 01/01                 |       | 108,176                                   |       | 04/06                                            |       | n/a                                  |       | 01/06                                                  |       | 2036                                       |
| Mid Ocean CBO 2001-1 Ltd.          |       | 10/01                 |       | 123,661                                   |       | 02/06                                            |       | n/a                                  |       | 01/06                                                  |       | 2036                                       |
| Oceanview CBO I, Ltd.              |       | 06/02                 |       | 148,845                                   |       | 06/06                                            |       | 06/12                                |       | 06/06                                                  |       |    2032, 2037 (7) |
| Northlake CDO I, Limited           |       | 02/03                 |       | 110,709                                   |       | 03/06                                            |       | 03/13                                |       | 03/07                                                  |       |    2033, 2038 (7) |
| Knollwood CDO Ltd.                 |       | 03/04                 |       | 111,006                                   |       | 04/07                                            |       | 04/12                                |       | 04/08                                                  |       | 2039                                       |
| River North CDO Ltd.               |       | 01/05                 |       | 195,233                                   |       | 02/09                                            |       | 02/13                                |       | 02/09                                                  |       | 2040                                       |
| Buckingham CDO Ltd.                |       | 07/05                 |       | 781,089                                   |       | 08/10                                            |       | 08/13                                |       | 08/10                                                  |       | 2040                                       |
| Pinetree CDO Ltd.                  |       | 11/05                 |       | 172,799                                   |       | 01/10                                            |       | 01/14                                |       | 01/10                                                  |       | 2045                                       |
| Buckingham CDO II Ltd.             |       | 12/05                 |       | 1,087,700                                 |       | 03/11                                            |       | 03/14                                |       | 03/11                                                  |       | 2041                                       |
| Knollwood CDO II Ltd.              |       | 07/06                 |       | 66,072                                    |       | 07/09                                            |       | 07/13                                |       | n/a                                                    |       | 2046                                       |
| Buckingham CDO III Ltd.            |       | 08/06                 |       | 993,946                                   |       | 09/11                                            |       | 09/14                                |       | 09/11                                                  |       | 2051                                       |
| Aramis CDO                         |       | 03/07                 |       | 4,030                                     |       | 03/12                                            |       | n/a                                  |       | n/a                                                    |       | 2047                                       |
| **Total ABS CDOs**                 |       |                  |       | 3,903,266                                 |       |                                             |       |                                 |       |                                                   |       |                                       |
|                               |       |                  |       |                                      |       |                                             |       |                                 |       |                                                   |       |                                       |
| **Corporate Bond CDOs:**           |       |                  |       |                                      |       |                                             |       |                                 |       |                                                   |       |                                       |
| Valeo Investment Grade CDO Ltd.    |       | 01/01                 |       | 252,723                                   |       | 01/05                                            |       | n/a                                  |       | 01/06                                                  |       | 2013                                       |
| Valeo Investment Grade CDO II Ltd. |       | 05/01                 |       | 255,577                                   |       | 06/05                                            |       | n/a                                  |       | 06/06                                                  |       | 2013                                       |
| Robeco CDO II Limited              |       | 08/01                 |       | 112,036                                   |       | 08/05                                            |       | n/a                                  |       | 02/06                                                  |       | 2013                                       |
| Mayfair Euro CDO I B.V. (6)        |       | 06/01                 |       | 102,095                                   |       | 05/06                                            |       | n/a                                  |       | 05/06                                                  |       | 2013                                       |
| **Total Corporate Bond CDOs**      |       |                  |       | 722,431                                   |       |                                             |       |                                 |       |                                                   |       |                                       |
|                               |       |                  |       |                                      |       |                                             |       |                                 |       |                                                   |       |                                       |
| **Total CDO AUM**                  |       |                  |       | $                                         | 8,542,912  |                                             |       |                                 |       |                                                   |       |                                       |   |

 

----

(1)           CDO AUM numbersgenerally reflect the aggregate principal or notional balance of the collateraland, in some cases, the cash balance held by the CDOs and are as of the date ofthe last trustee report received for each CDO prior to April 1, 2010.

 

(2)           CDOs aregenerally callable by equity holders once per quarter beginning on the “firstoption call date” and subject to satisfaction of certain conditions.

 

(3)           ABS CDOsgenerally contain a provision requiring the manager thereof to attempt toliquidate the collateral held therein on the “auction call date,” subject tocertain conditions, generally including that the proceeds from any suchliquidation be sufficient to redeem the notes and pay certain additionalexpenses.

 

(4)           Termination ofreinvestment period refers to the date after which we can no longer use certainprincipal collections to purchase additional collateral, and such collectionsare instead used to repay the outstanding amounts of certain debt securitiesissued by the CDO.

 

(5)           We are notcontractually entitled to receive any management fees from this CLO so long as100% of the equity is held by DC LLC or an affiliate thereof.

 

(6)           The AUM for ourEuro-denominated CDOs has been converted into U.S. dollars using the spot rateof exchange on March 31, 2010.

 

(7)           Maturity datevaries by tranche of notes.

 

TheCDOs that we manage generally contain certain structural provisions, includingbut not limited to overcollateralization requirements, that are meant toprotect investors from deterioration in the credit quality of the underlyingcollateral pool. During 2009, we experienced increased defaults and downgradesof the collateral underlying our CDOs, which has put downward pressure onovercollateralization ratios and increased the likelihood that the CDOs wemanage will experience events of default or trigger other structuralprovisions. Noncompliance with overcollateralization 

 

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tests and other structuralprovisions may cause cash flows from the CDOs to be diverted to prepay the debtsecurities issued by the CDOs, which may decrease the asset base on which ourfuture management fees are calculated and typically results in the deferral ofthe payment of our subordinated management fees. In addition, in certain cases,noncompliance with these overcollateralization tests or other structuralprovisions can lead to events of default under the indentures governing theCDOs and, ultimately, acceleration of the notes issued by the CDO and theliquidation of the underlying collateral. Certain of our CDOs containprovisions prohibiting the liquidation of the CDO following an event of defaultunless either the proceeds from the liquidation will be sufficient to pay offall of the notes issued by the CDO along with certain specified expenses or amajority or supermajority of certain specified classes of notes vote toliquidate the CDO. We believe that CDOs that contain these provisions are lesslikely to liquidate upon the occurrence of an event of default. In addition,certain CDOs we manage contain provisions where noncompliance withovercollateralization tests causes us to become subject to removal asinvestment manager at the discretion of certain classes of investors.

 

CLOinvestment advisory fee revenue increased by $2.1 million for the threemonths ended March 31, 2010, as compared to the three months ended March 31,2009. This increase in CLO investment advisory fee revenue is due to thepayment of previously deferred subordinated management fees during the threemonths ended March 31, 2010.  Weearned subordinated management fees on our cash flow CLOs of $1.4 millionfor both the three months ended March 31, 2010 and 2009. During the threemonths ended March 31, 2010, all $2.1 million of performance feesrepresent previously deferred subordinated management fees.

 

Weexpect a portion of our CLO subordinated management fees to continue to bedeferred in the near term. As a result of improvement in market conditions andeffective portfolio management, certain of our CLOs have returned to compliancewith their overcollateralization tests, and we have begun to recoup some of ourdeferred subordinated management fees from those CLOs and expect those CLOs topay future subordinated management fees on a current basis.  Withcontinued improvement in market conditions and ongoing effective portfoliomanagement, we expect our other CLOs to return to compliance with theirovercollateralization tests, and, subject to the satisfaction of certain otherconditions, we would expect to recoup at least a portion and potentiallysubstantially all of our deferred subordinated management fees from those CLOsand to receive future subordinated management fees on a current basis. As of March 31,2010, our CLOs have unrecognized deferred subordinated management fees totalingapproximately $7.0 million.

 

ABSCDO revenue declined by $0.3 million for the three months ended March 31,2010 as compared to the three months ended March 31, 2009, primarilyconsisting of a decline in senior management fees of $0.3 million due to adecline in AUM on one of our ABS CDOs resulting from an increase in defaultedsecurities in that deal. We expect our ABS CDO AUM and management fees tocontinue to decline as a result of both the diversion of cash flows to prepaythe debt securities issued by those CDOs based on continued noncompliance withovercollateralization tests and other structural provisions and additionaldefaults and ratings downgrades with respect to the underlying collateral inthose CDOs.

 

Weare continuing to focus on our previously announced strategy of acquiringexisting CDO management contracts. On July 17, 2008, we acquired themanagement contract for Robeco CDO, and, on February 11, 2009, we assumedthe management contract for Mayfair Euro CDO. In addition on March 23, 2010, we announced ourentry into a definitive agreement with Bounty and CNCIM to acquire all of theoutstanding equity interests of CNCIM, an investment manager with four CLOsunder management, from Bounty, which will provide a significant increase in ourCDO AUM and management fee income.

 

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*Other Investment Advisory Fees*

 

Thefollowing table summarizes the investment advisory fee revenues for ourinvestment management contracts related to our separately managed accounts andother investment vehicles:

 
| ** **                                                      | ** ** | **Average  AUM (1)** | ** ** | **Management  Fees** | ** ** | **Performance  Fees** | ** ** |
|-----------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | ** **           | ** ** | **(In thousands)**   | ** ** | ** **            | ** ** |
| **Three  months ended March 31, 2010:**                    |       |                 |       |                 |       |                  |       |
| Separately  managed accounts                                    |       | $                    | 320,095    |                 | $          | 196                   |       | n/a |   |
| Other investment  vehicle (2)                                   |       | $                    | 22,639     |                 | $          | —                |       | $ | — |   |
|                                                            |       |                 |       |                 |       |                  |       |
| **Three  months ended March 31, 2009:**                    |       |                 |       |                 |       |                  |       |
| Separately  managed accounts and other investment advisory fees |       | $                    | 294,676    |                 | $          | 244                   |       | n/a |   |
|                                                                 |            |                      |            |                      |            |                       |            |  |  |  |

 

----

(1)           Average AUM iscalculated as the average of the AUM on the first day of January, February andMarch.

 

(2)           Represents AUMfor DPLC.  As of January 1, 2010,Deerfield and Pegasus agreed to temporarily suspend payment of management feesrelated to DPLC.

 

n/a—not applicable

 

Thereduction in other investment advisory fees during the three months ended March 31,2010, as compared to the three months ended March 31, 2009, was primarilythe result of agreements with DPLC and one of our separately managed accountspursuant to which DCM is not currently charging investment advisory fees formanagement of those vehicles.

* *

*Intercompanyinvestment advisory fees*

 

Asa result of the consolidation of the CIP CDOs in the Consolidated InvestmentProducts segment effective January 1, 2010, we earned intercompanyinvestment advisory fees of $3.6 million for the three months ended March 31,2010, which were eliminated upon consolidation.

 

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***Expenses***

 

Thefollowing table summarizes our Investment Management segment expenses for theperiods presented:

 
| ** **                                    | ** ** | **Three months ended March 31,** | ** ** | **Variance**      | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|-------------------|------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009**          | ** ** | **2010 vs. 2009** | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | **(In millions)** | ** ** | ** ** | ** ** |
| Salaries                                      |       | $                                     | 2.0        |              | $          | 2.2 |   | $ | (0.2 | ) |
| Incentive  compensation                       |       | 0.7                                   |       | 1.0               |       | (0.3 | ) |
| Employee  benefits                            |       | 0.1                                   |       | 0.2               |       | (0.1 | ) |
| Total  compensation and benefits              |       | 2.8                                   |       | 3.4               |       | (0.6 | ) |
|                                          |       |                                  |       |              |       |   |   |
| Audit and  audit-related fees                 |       | 0.1                                   |       | 0.1               |       | — |   |
|                                          |       |                                  |       |              |       |   |   |
| Insurance  expense                            |       | 0.1                                   |       | 0.1               |       | — |   |
|                                          |       |                                  |       |              |       |   |   |
| Software and  data feeds                      |       | 0.2                                   |       | 0.3               |       | (0.1 | ) |
| Other general  and administrative fees        |       | 0.2                                   |       | 0.2               |       | — |   |
| Total general  and administrative expense     |       | 0.4                                   |       | 0.5               |       | (0.1 | ) |
|                                          |       |                                  |       |              |       |   |   |
| Fixed asset  depreciation                     |       | 4.5                                   |       | 0.3               |       | 4.2 |   |
| Intangible asset  amortization                |       | 1.3                                   |       | 1.3               |       | — |   |
| Total  depreciation and amortization          |       | 5.8                                   |       | 1.6               |       | 4.2 |   |
|                                          |       |                                  |       |              |       |   |   |
| Occupancy                                     |       | 0.5                                   |       | 0.6               |       | (0.1 | ) |
|                                          |       |                                  |       |              |       |   |   |
| Cost savings  initiative                      |       | —                                |       | 0.2               |       | (0.2 | ) |
|                                          |       |                                  |       |              |       |   |   |
| Impairment of  intangible assets              |       | 0.2                                   |       | —            |       | 0.2 |   |
|                                          |       |                                  |       |              |       |   |   |
| Total Investment  Management segment expenses |       | $                                     | 9.9        |              | $          | 6.5 |   | $ | 3.4 |   |

 

Theincrease in expenses of $3.4 million for the three months ended March 31,2010, as compared to the three months ended March 31, 2009, was primarilyattributable to a $4.2 million increase in fixed asset depreciation partiallyoffset by a $0.6 million decrease in compensation and benefits.

 

OnNovember 27, 2009, we entered into an amendment (the “Lease Amendment”) toour original lease agreement dated July 11, 2005 (as amended, the “Lease”).Pursuant to the Lease Amendment, we vacated our original premises on April 30,2010 and relocated to 25,470 square feet of office space on the 12th floor in the samebuilding (the “New Premises”). The term for the rental of the New Premisesbegins on October 1, 2010 and will expire on February 28, 2021. As aresult of the relocation to the New Premises, our annual rent expense under theLease will be reduced by approximately $1.3 million to reflect the reducedsquare footage of the New Premises.

 

Inconnection with the Lease Amendment, we are recognizing a non-cash accelerationof depreciation and amortization expense related to certain leaseholdimprovements and fixed assets on the original premises as a result of a shorterestimated life for the use of those assets. The total impact of theacceleration of the depreciation and amortization expense is approximately $6.9 million,which we expensed ratably from the date the Lease Amendment was signed (November 27,2009) to the date on which we vacated the Original Premises (April 30,2010). The impact of the accelerated depreciation for the three months ended March 31,2010 was approximately $4.1 million.

 

The$0.6 million decrease in compensation and benefits for the three months ended March 31,2010, as compared to the three months ended March 31, 2009, was primarilythe result of our continued focus on cost savings and reduced incentivecompensation. As of March 31, 2010 and March 31, 2009, we had 67 and65 employees, respectively.

 

Duringthe three months ended March 31, 2010, we recorded $0.2 million ofimpairment charges on the intangible assets associated with the managementcontract for Oceanview CBO I, Ltd., as DCM is no longer the manager of thisCDO.

 

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***Other Income and Gain (Loss)***

 

Otherincome and gain (loss) for the Investment Management segment primarilyconsisted of the realized and unrealized gains related to our investments inpreference shares of CDOs that are managed by DCM and beneficial interests inCDOs. During the three months ended March 31, 2010, we recognized netunrealized gains of $1.2 million in net gain (loss) on investments at fairvalue in the condensed consolidated statements of operations related to theseinvestments. During the three months ended March 31, 2009, we recognizednet unrealized losses of $0.1 million in net gains (loss) on investmentsat fair value in the condensed consolidated statements of operations related tothese investments.

 

***Income Tax Expense***

 

Forthe three months ended March 31, 2010, the Investment Management segmentrecorded income tax expense of $400 related to Deerfield Capital Management(Europe) Limited (“DCM Europe”). There is a full valuation allowance on all ofour deferred tax assets except for those associated with DCM Europe.

 

**Principal Investing Segment**

 

***Revenues***

 

OurPrincipal Investing segment revenues represent the net spread, or difference,between the interest income we earn on our investment portfolio and the cost ofour borrowings. We also recognize the impact of our provision for loan losseson our Principal Investing segment revenues. The following table summarizes thePrincipal Investing segment revenues:

 
| ** **                                  | ** ** | **Three months ended March 31,** | ** ** | **Variance** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|--------------|------------|
| ** **                                  | ** ** | **2010**                              | ** ** | **2009**     | ** ** | **2010 vs. 2009** | ** ** |
| ** **                                  | ** ** | **(In millions)**                     | ** ** |
| **Principal  Investing Segment Revenues**   | ** ** | ** **                            |       |         |       |   |   |
| Interest income                             |       | $                                     | 7.3        |         | $          | 13.7 |   | $ | (6.4 | ) |
| Interest expense                            |       | 1.8                                   |       | 5.7          |       | 3.9 |   |
| Net interest  income                        |       | 5.5                                   |       | 8.0          |       | (2.5 | ) |
| Provision for  loan losses                  |       | 4.2                                   |       | 2.1          |       | (2.1 | ) |
| Total Principal  Investing segment revenues |       | $                                     | 1.3        |         | $          | 5.9 |   | $ | (4.6 | ) |

 

Thefollowing table summarizes our Principal Investing segment interest income:

 
| ** **                                   | ** ** | **Three months ended March 31,** | ** ** | ** ** | **Variance** | ** ** | ** **        | **% of total interest income** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|------------|--------------|------------|-------------------|--------------------------------|------------|
| ** **                                   | ** ** | **2010**                              | ** ** | **2009**   | ** **   | ** ** | **2010 vs. 2009** | ** **                     | ** ** | **Three months ended March 31,** | ** ** |
| ** **                                   | ** ** | **(In millions)**                     | ** ** | ** ** | **2010**     | ** ** | ** **        | **2009**                       | ** ** |
| **Real  Estate Investments:**                | ** ** | ** **                            |       |       |         |       |              |                           |       |   |   |   |   |   |
| RMBS                                         |       | $                                     | 1.4        |       | $            | 4.5        |              |                           | $          | (3.1 | ) |   | 19.2 | % |   | 32.8 | % |
| Corporate loans  and securities:             |       |                                  |       |       |         |       |              |                           |       |   |   |   |   |   |
| Loans held in  DFR MM CLO                    |       | 5.6                                   |       | 5.8        |         |       | (0.2              | )                              |       | 76.7 | % |   | 42.4 | % |
| Loans held in  the Wachovia Facility         |       | —                                |       | 0.6        |         |       | (0.6              | )                              |       | 0.0 | % |   | 4.4 | % |
| Assets held in  Market Square CLO            |       | —                                |       | 3.1        |         |       | (3.1              | )                              |       | 0.0 | % |   | 22.6 | % |
| Assets held in  DPLC                         |       | 0.2                                   |       | —     |         |       | 0.2               |                           |       | 2.7 | % |   | 0.0 | % |
| Commercial real  estate loans and securities |       | —                                |       | (0.1       | )            |       | 0.1               |                           |       | 0.0 | % |   | -0.7 | % |
| Other  investments at fair value             |       | 0.1                                   |       | (0.2       | )            |       | 0.3               |                           |       | 1.4 | % |   | -1.5 | % |
| **Total interest income**                    |       | $                                     | 7.3        |       | $            | 13.7       |              |                           | $          | (6.4 | ) |   | 100.0 | % |   | 100.0 | % |

 

Thedecrease in interest income of $6.4 million for the three months ended March 31,2010, as compared to the three months ended March 31, 2009, wasattributable primarily to a $3.1 million, $3.1 million and $0.6 milliondecrease in interest income earned on RMBS, assets held in Market Square CLOand loans held in our alternative asset revolving Warehouse Funding Facilitywith Wachovia Capital Markets LLC (the “Wachovia Facility”) respectively,partially offset by an increase of $0.2 million and $0.3 million in interestincome earned on assets held in DPLC and other investments at fair value,respectively.  The decrease in interestincome earned on RMBS was primarily attributable to a decrease in our threemonth average RMBS holdings, which resulted in an $0.8 million decrease ininterest income, an acceleration of amortization due to approximately $43.2million in paydowns in the first three months of 2010, which resulted in a $1.7million decrease to interest income, and an increase of approximately $0.6million in amortization of premium due to a large number of purchases atpremiums in 2009, which reduced interest income.  We deconsolidated Market Square CLO as of 

 

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June 30, 2009;therefore, no interest income related to Market Square CLO was recorded for thethree months ended March 31, 2010, which resulted in a $3.1 milliondecrease in interest income as compared to the three months ended March 31,2009.  Also, we fully repaid the WachoviaFacility in 2009 and all loans in that portfolio were sold or transferred;therefore no interest income related to the Wachovia Facility was recorded forthe three months ended March 31, 2010, which resulted in a $0.6 milliondecrease in interest income as compared to the three months ended March 31,2009.  DPLC began operations in April 2009;therefore, no interest income related to DPLC was recorded for the three monthsended March 31, 2009 which resulted in a $0.2 million increase in interestincome as compared to the three months ended March 31, 2009.  The $0.3 million increase in interest incomerelated to other investments at fair value is primarily related to the factthat, for the three months ended March 31, 2009, there was a one-timeimpairment charge to one of our non-marketable equity securities.

 

Thefollowing table summarizes our Principal Investing segment interest expense:

 
| ** **                            | ** ** | **Three months ended March 31,** | ** ** | **Variance** | ** ** |              |
|---------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------|
| ** **                            | ** ** | **2010**                              | ** ** | **2009**     | ** ** | **2010 vs. 2009** | ** ** |   |
| ** **                            | ** ** | **(In millions)**                     | ** ** |
| Repurchase  agreements                |       | $                                     | 0.3        |         | $          | 0.7               |   | $ | (0.4 | ) |   |
| Hedging activity                      |       | —                                |       | 0.1          |       | (0.1              | ) |   |
| Long term debt:                       |       |                                  |       |         |       |              |   |   |
| Recourse:                             |       |                                  |       |         |       |              |   |   |
| Subordinated  debt and securities (1) |       | 0.8                                   |       | 1.4          |       | (0.6              | ) |   |
| Non-Recourse:                         |       |                                  |       |         |       |              |   |   |
| DFR MM CLO                            |       | 0.5                                   |       | 1.5          |       | (1.0              | ) |   |
| Market Square  CLO                    |       | —                                |       | 1.6          |       | (1.6              | ) |   |
| Total long term  debt                 |       | 1.3                                   |       | 4.5          |       | (3.2              | ) |   |
| Amortization of  debt issuance cost   |       | 0.2                                   |       | 0.4          |       | (0.2              | ) |   |
| Total interest  expense               |       | $                                     | 1.8        |         | $          | 5.7               |   | $ | (3.9 | ) |   |

 

----

(1)           Subordinateddebt and securities includes interest expense for both the Trust PreferredSecurities and Junior Subordinated Debt.

 

Thedecrease in interest expense of $3.9 million for the three months ended March 31,2010, as compared to the three months ended March 31, 2009, was primarilythe result of reduced repurchase agreement and long term debt balances and to alesser extent a lower interest rate environment. The decrease in both theaverage outstanding repurchase agreement balance and weighted average borrowingrate for the three months ended March 31, 2010, as compared to the threemonths ended March 31, 2009, contributed to a $0.4 million decreasein interest expense.

 

Theinterest expense related to long term debt decreased by $3.2 million forthe three months ended March 31, 2010, as compared to the three monthsended March 31, 2009. The deconsolidation of Market Square CLO on June 30,2009 provided a decrease in interest expense of $1.6 million for the threemonths ended March 31, 2010, as compared to the three months ended March 31,2009. Lower outstanding long term debt balances and lower interest rates on DFRMM CLO provided a decrease in interest expense of $1.0 million for thethree months ended March 31, 2010, as compared to the three months ended March 31,2009.

 

Theinterest expense related to the subordinated debt and securities decreased by$0.6 million primarily due to a decrease in the average borrowing rate for thethree months ended March 31, 2010, as compared to the three months ended March 31,2009. Three-month LIBOR averaged a decrease of 2.0% for the three months ended March 31,2010 as compared to the three months ended March 31, 2009. Additionally,on March 4, 2010, in connection with the Exchange Agreement, the interestrate was reduced to a fixed rate of 1.0% on the Junior Subordinated Debt.

 

Interestexpense will continue to decline as compared to prior periods primarily relatedto our Junior Subordinated Debt as a result of the Exchange Agreement, which,among other things, reduced our interest rate to a fixed rate of 1.0% per annumuntil at least December 2012 and possibly through April 30, 2015 ifcertain specified events occur. Additionally, we expect a further net reductionin interest expense as a result of the extinguishment of the Series A &Series B Notes, although this will be partially offset by an increase ininterest expense associated with the expected issuance of the ConvertibleNotes.

 

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***Provision for Loan Losses***

 

Thefollowing table summarizes our Principal Investing segment provision for loanlosses:

 
| ** **                       | ** ** | **Year ended March 31,** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(In millions)**             | ** ** |
| Loans held in  DFR MM CLO        |       | $                             | 4.2        |   | $ | 0.8 |   |
| Commercial real  estate loans    |       | —                        |       | 1.3 |   |
| Total provision  for loan losses |       | $                             | 4.2        |   | $ | 2.1 |   |

 

Duringthe three months ended March 31, 2010 and March 31, 2009, werecognized provisions for loan losses of $4.2 million and $2.1 million,respectively.  During the three monthsended March 31, 2010, we recorded provisions for loan losses of $4.2million related to four loans held in DFR MM CLO with total outstandingprincipal of $9.8 million. During the three months ended March 31, 2009,we recorded provisions for loan losses of $0.8 million related to two loansheld in DFR MM CLO with total outstanding principal of $17.7 million and $1.3million related to three commercial real estate loans still being held forinvestment with total outstanding principal of $10.1 million.

 

***Expenses***

 

Thefollowing table summarizes Principal Investing segment expenses for the periodspresented:

 
| ** **                                  | ** ** | **Three months ended March 31,** | ** ** | **Variance** | ** ** |              |
|---------------------------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------|
| ** **                                  | ** ** | **2010**                              | ** ** | **2009**     | ** ** | **2010 vs. 2009** | ** ** |   |
| ** **                                  | ** ** | **(In millions)**                     | ** ** |
|                                        | ** ** | ** **                            | ** ** | ** **   | ** ** | ** **        | ** ** |   |
| Audit and  audit-related fees               |       | $                                     | 0.2        |         | $          | 0.1               |   | $ | 0.1 |   |   |
| Legal fees                                  |       | 1.3                                   |       | 0.4          |       | 0.9               |   |   |
| Other  professional fees                    |       | 0.3                                   |       | 0.1          |       | 0.2               |   |   |
| Total  professional services                |       | 1.8                                   |       | 0.6          |       | 1.2               |   |   |
|                                        |       |                                  |       |         |       |              |   |   |
| Insurance  expense                          |       | 0.6                                   |       | 0.7          |       | (0.1              | ) |   |
|                                        |       |                                  |       |         |       |              |   |   |
| Board of  directors fees                    |       | 0.5                                   |       | 0.3          |       | 0.2               |   |   |
| Banking and  other administrative fees      |       | 0.1                                   |       | 0.1          |       | —            |   |   |
| Warrant expense                             |       | 0.5                                   |       | —       |       | 0.5               |   |   |
| Other general  and administrative fees      |       | 0.1                                   |       | —       |       | 0.1               |   |   |
| Total general  and administrative expenses  |       | 1.2                                   |       | 0.4          |       | 0.8               |   |   |
|                                        |       |                                  |       |         |       |              |   |   |
| Total Principal  Investing segment expenses |       | $                                     | 3.6        |         | $          | 1.7               |   | $ | 1.9 |   |   |

 

Theincrease in expenses of $1.9 million for the three months ended March 31,2010, as compared to the same period in 2009, was attributable to increases inprofessional services and general and administrative expenses of $1.2 millionand $0.8 million, respectively, offset by decreases in insurance expense of$0.1 million. The increase in total professional services of $1.2 millionwas primarily related to the proposed strategic transactions.  The $0.8 million increase in general andadministrative expenses was primarily related to the DPLC RestructuringWarrants and an increase in the Board’s fees of $0.2 million.

 

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***Other Income and Gain (Loss)***

 

Thefollowing table summarizes our Principal Investing segment other income andgain (loss) for the periods presented:

 
| ** **                                               | ** ** | **Three months ended March 31,** | ** ** | ** ** | **Variance** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|------------|--------------|------------|
| ** **                                               | ** ** | **2010**                              | ** ** | ** ** | **2009**     | ** ** | ** ** | **2010 vs. 2009** | ** ** |
| ** **                                               | ** ** | **(In millions)**                     |
| Net realized  gain (loss) on investments at fair value   |       | $                                     | 2.3        |       |         | $          | — |   |   | $ | 2.3 |   |
| Net unrealized  gain (loss) on investments at fair value |       | 1.0                                   |       |       | 5.3          |       |   | (4.3 | ) |
| Net gain on  investments at fair value                   |       | 3.3                                   |       |       | 5.3          |       |   | (2.0 | ) |
|                                                     |       |                                  |       |       |         |       |   |   |   |
| Net realized gain  (loss) on loans                       |       | 0.3                                   |       |       | (5.2         | )          |   | 5.5 |   |
| Net unrealized  gain (loss) on loans                     |       | 2.5                                   |       |       | 11.0         |       |   | (8.5 | ) |
| Net gain on  loans                                       |       | 2.8                                   |       |       | 5.8          |       |   | (3.0 | ) |
|                                                     |       |                                  |       |       |         |       |   |   |   |
| Net realized  (loss) gain on interest rate swaps         |       | (0.2                                  | )          |       | 0.5          |       |   | (0.7 | ) |
| Net realized  loss on credit default swaps               |       | —                                |       |       | (0.5         | )          |   | 0.5 |   |
| Net unrealized  gain (loss) on interest rate swaps       |       | 0.2                                   |       |       | (0.7         | )          |   | 0.9 |   |
| Net unrealized  gain on credit default swaps             |       | —                                |       |       | 0.4          |       |   | (0.4 | ) |
| Net unrealized  loss on warrants                         |       | (0.1                                  | )          |       | (0.1         | )          |   | — |   |
| Net loss on  derivatives                                 |       | (0.1                                  | )          |       | (0.4         | )          |   | 0.3 |   |
|                                                     |       |                                  |       |       |         |       |   |   |   |
| Dividend income                                          |       | 0.3                                   |       |       | —       |       |   | 0.3 |   |
|                                                     |       |                                  |       |       |         |       |   |   |   |
| Net other income  and gain                               |       | $                                     | 6.3        |       |         | $          | 10.7 |   |   | $ | (4.4 | ) |
|                                                     |       |                                  |       |       |         |       |   |   |   |
| Total realized  gain (loss)                              |       | $                                     | 2.7        |       |         | $          | (5.2 | ) |   | $ | 7.9 |   |
| Total unrealized  gain                                   |       | $                                     | 3.6        |       |         | $          | 15.9 |   |   | $ | (12.3 | ) |

 

Netother income and gain declined by $4.4 million for the three months ended March 31,2010 as compared to the three months ended March 31, 2009. This declinewas primarily attributable to decreases in net gains on investments at fairvalue and loans of $2.0 million and $3.0 million, respectively,partially offset by decreases to the net loss on derivatives and increases todividend income of $0.3 million and $0.3 million, respectively.

 

Duringthe three months ended March 31, 2010, the net gains on investments atfair value were $3.3 million, primarily driven by $2.4 million in netgains on other investments at fair value, $0.6 million in net gains on the RMBSportfolio and $0.5 million in net gains on the DPLC portfolio.

 

Netgain on loans for the three months ended March 31, 2010 primarily consistsof $2.8 million in realized gains on sales of loans out of DFR MM CLO.  For the three months ended March 31,2009, we realized net losses on sales of loans of $5.2 million, primarilyas a result of an agreement to sell loans held within the Wachovia Facility,partially offset by an increase in loan valuations in that period.

 

Thedecrease in net loss on derivatives for the three months ended March 31,2010, as compared to the three months ended March 31, 2009, is the resultof decreases in the number of credit default swaps and interest rate swaps. Theincrease in dividend income is the result of a $0.3 million dividend receivedon one of our equity positions during the three months ended March 31,2010.

 

***Income Tax Expense***

 

Forthe three months ended March 31, 2010, the Principal Investing segmentrecorded no income tax expense. This amount is net of a full valuationallowance on our deferred tax assets.

 

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**Consolidated Investment Products Segment**

 

The Consolidated Investment Products Segmentwas established on January 1, 2010 consistent with the consolidationguidance of the amendments to ASC Topic 810. As such, there is no prior periodcomparable data.

 

***Revenues***

 

TheConsolidated Investment Products segment revenues represent the net spread, ordifference, between the interest income earned on the collateral assets held bythe CIP CDOs and the cost of the borrowings of the CIP CDOs that areconsolidated in accordance with the amendments to ASC Topic 810. The collateral assets of the CIP CDOs areavailable solely to satisfy the obligations of the CIP CDOs. We have no rightto the benefits from, nor do we bear the risks associated with, the collateralassets held by the CIP CDOs, beyond our minimal direct investments in, andmanagement fees generated from, the CIP CDOs. If we were to liquidate, thecollateral assets would not be available to our general creditors, and as aresult, we do not consider them to be our assets. Additionally, the investorsin the CIP CDOs have no recourse to us for the notes issued by the CIP CDOs. Wetherefore do not consider this debt to be an obligation of ours. The followingtable summarizes the Consolidated Investment Products segment revenues:

 
| ** **                                             | ** ** | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------------|------------|------------|---------------------------------------|------------|
| ** **                                             | ** ** | ** ** | **2010**                              | ** ** |
| ** **                                             | ** ** | ** ** | **(In millions)**                     | ** ** |
| **Consolidated  Investment Products Segment Revenues** |       |       |                                  |       |
| Interest income                                        |       |       | $                                     | 24.3       |   |
| Interest expense                                       |       |       | 4.8                                   |       |
| Net interest  income                                   |       |       | $                                     | 19.5       |   |

 

Netinterest income is primarily composed of $20.3 million of interest income onloans and $4.0 million of interest income on corporate bonds, partially offsetby $4.8 million of interest expense on non-recourse long term debt.

 

***Expenses***

 

Thefollowing table summarizes our Consolidated Investment Products segmentexpenses for the three months ended March 31, 2010:

 
| ** **                                               | ** ** | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------------|------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | ** ** | **2010**                              | ** ** |
| ** **                                               | ** ** | ** ** | **(In millions)**                     | ** ** |
|                                                     | ** ** | ** ** | ** **                            | ** ** |
| Management fee  expense to related party                 |       |       | $                                     | 3.6        |   |
|                                                     |       |       |                                  |       |
| Audit and  audit-related fees                            |       |       | 0.2                                   |       |
| Other  professional fees                                 |       |       | 0.2                                   |       |
| Total  professional services                             |       |       | 0.4                                   |       |
|                                                     |       |       |                                  |       |
| Other general  and administrative fees                   |       |       | 0.2                                   |       |
|                                                     |       |       |                                  |       |
| Total  Consolidated Investment Products segment expenses |       |       | $                                     | 4.2        |   |

 

Themost significant expense for the Consolidated Investment Products segment isthe management and incentive fee expense to related party of $3.6 million,which is eliminated upon consolidation. This amount is charged by ourInvestment Management segment in connection with the CIP CDO managementcontracts with DCM.

 

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** **

**Other Income and Gain (Loss)**

 

The following table summarizes our Consolidated Investment Productssegment other income and gain (loss) for the three months ended March 31,2010:

 
| ** **                              | ** ** | **Three months ended March 31,** |
|-----------------------------------------|------------|---------------------------------------|
| ** **                              | ** ** | **2010**                              |
| ** **                              | ** ** | **(In millions)**                     |
| Net  realized gain on loans             |       | $                                     | 7.1 |   |
| Net  unrealized gain on loans           |       | 59.3                                  |   |
| Net  gain on loans                      |       | 66.4                                  |   |
| ** **                              | ** ** | ** **                            | ** ** |
| Net  realized gain on corporate bonds   |       | 0.3                                   |   |
| Net  unrealized gain on corporate bonds |       | 3.3                                   |   |
| Net  gain on corporate bonds            |       | 3.6                                   |   |
|                                    |       |                                  |   |
| Net  unrealized loss on derivatives     |       | (0.6                                  | ) |
|                                    |       |                                  |   |
| Net  realized loss on liabilities       |       | (1.7                                  | ) |
| Net  unrealized loss on liabilities     |       | (87.6                                 | ) |
| Net  loss on liabilities                |       | (89.3                                 | ) |
|                                    |       |                                  |   |
| Other  net gain                         |       | 0.8                                   |   |
|                                    |       |                                  |   |
| Net  other income and gain              |       | $                                     | (19.1 | ) |
|                                    |       |                                  |   |
| Total  realized gain                    |       | $                                     | 6.5 |   |
| Total  unrealized loss                  |       | $                                     | (25.6 | ) |

 

Other income and gain for the Consolidated Investment Products segmentconsisted of realized and unrealized gains on loans, corporate bonds and otherinvestments.  During the three monthsended March 31, 2010, this segment recognized $6.5 million of realizedgains and $25.6 of unrealized losses in net other income and gain.

 

**Off-Balance Sheet Arrangements**

 

Through our wholly-owned subsidiary, DC LLC, we own 100% of thecommon shares of Trust I. Trust I, a VIE, was formed in September 2005 andissued, in the aggregate, $25.0 million of preferred shares tounaffiliated investors. DC LLC issued junior subordinated debt securitiesto Trust I in the aggregate of $25.8 million which remain outstanding, andare guaranteed by us. The rights of the holders of common shares of Trust I aresubordinate to the rights of the holders of preferred shares only in the eventof a default. Otherwise, the common stockholders’ economic and voting rightsrank pari passu with the preferred stockholders. We record the investment inthe Trust I common shares as other investments at cost and record dividendincome upon declaration by the Trust. The junior subordinated debt securitiesare recorded as long term debt, and debt issuance costs are deferred in prepaidand other assets in the consolidated balance sheet. Interest on the debtsecurities and amortization of debt issuance costs are recorded in theconsolidated statements of operations as interest expense.

 

As of March 31, 2010, we did not maintain any other relationshipswith unconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance, special purpose or VIEs, established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes. Further, as of March 31, 2010, we had notguaranteed any obligations of unconsolidated entities or entered into anycommitment or intent to provide additional funding to any such entities, otherthan Trust I.

 

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**Liquidityand Capital Resources**

 

We held cash and cash equivalents of $36.3 million as of March 31,2010.

 

Our operating activities used cash of $32.4 million for the threemonths ended March 31, 2010, primarily through the following:

 

Net inflows and non-cash adjustments of $34.7 million, consistingof the following:

 

·                  Net loss—$3.3 million

 

·                  Provision for loanlosses—$4.2 million

 

·                  Depreciation andamortization—$5.7 million

 

·                  Net change in operatingassets and liabilities—$27.5 million

 

·                  Impairment of intangibleassets—$0.2 million

 

·                  Non-cash rentalexpense—$0.1 million

 

·                  Issuance of stockwarrants—$0.5 million

 

Net outflows and non-cash adjustments totaled $2.3 million,consisting of the following:

 

·                  Net purchases of investmentsat fair value—$16.5 million

 

·                  Net gain onloans—$2.8 million

 

·                  Net changes in undesignatedderivatives—$0.4 million

 

·                  Net gain on investments atfair value—$73.0 million

 

·                  Net loss on liabilities atfair value—$87.9 million

 

·                  Net premium and discountamortization on investments, loans and debt issuance—$1.7 million

 

Our investing activities provided cash of $18.5 million for the threemonths ended March 31, 2010, primarily from principal payments andproceeds from the sale of investments at fair value previously classified asavailable-for-sale of $69.8, principal payments and proceeds from loans of$35.6 and proceeds from the sale of loans previously classified as held forinvestment of $3.7 million, partially offset by the change in restrictedcash and cash equivalents of $53.3 million, the origination and purchase ofloans held for investment of $37.0 million and the purchases of fixedassets of $0.3 million.

 

Our financing activities used cash of $63.3 million for the threemonths ended March 31, 2010, primarily for payments on repurchaseagreements of $13.8 million, payments on long term debt of$43.6 million, equity distributions of $5.6 million and debt issuancecosts of $0.3 million.

 

***Leverage***

 

Our RMBS holdings were $303.3 million and $338.7 million asof March 31, 2010 and March 31, 2009, respectively. Our repurchaseagreements liabilities were $277.6 million and $318.6 million as of March 31,2010 and 2009, respectively. As discussed in more detail in the followingsection, *“Liquidity and Sources of Funds,”* ourremaining long term debt (other than the long term debt in the ConsolidatedInvestment Products segment) of $410.5 million consists of$217.3 million of non-recourse debt, $72.4 million of Series A &Series B Notes, due in 2012, $95.0 million of Junior Subordinated Debt and$25.8 million of Trust Preferred Securities.

 

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**Liquidity and Sources of Funds**

 

We believe that our current cash and cash equivalents, unencumberedliquid assets and net equity in our financed RMBS portfolio, along with cashflows from operations, among other things, are adequate to meet anticipatedlong-term (greater than one year) liquidity requirements. Unencumbered RMBS andunrestricted cash and cash equivalents aggregated $38.8 million at March 31,2010. In addition, net equity in our financed RMBS portfolio (includingassociated interest rate swaps), excluding the unencumbered RMBS includedabove, totaled $36.8 million at March 31, 2010. In total, we had unrestrictedcash and cash equivalents, unencumbered RMBS and net equity in the financedRMBS portfolio of $75.6 million as of March 31, 2010. As of March 31,2010, the fair value of our Agency RMBS and non-Agency RMBS portfolios were$300.8 million and $2.5 million, respectively. During the firstquarter of 2010, Fannie Mae and Freddie Mac announced and began to carry outits plans to buy “substantially” all mortgages held in RMBS pools issued undertheir respective programs that are delinquent by 120 days or more. Thisresulted in a significant increase in paydowns during the first quarter of 2010and a significant temporary increase in our net equity in RMBS as of March 31,2010, as reflected in other receivables in our condensed consolidated balancesheet.

 

On March 4, 2010, we entered into the Exchange Agreement with theholders of the Trust Preferred Securities. See “*Recourse Debt*” belowfor additional disclosure regarding the agreement.

 

We attempt to maintain our leverage at a level that we believe ensuresthat our cash and cash equivalents will be sufficient to satisfy our liquidityrequirements. If we are required to sell RMBS, sales at prices lower than theircarrying value would result in further realized losses and reduced income. Forfurther discussions concerning the availability of repurchase agreementfinancing, which we use to finance our RMBS portfolio, see *“Trends—Liquidity”* above. We may increaseour capital resources by consummating offerings of securities or issuing newdebt, possibly including preferred stock, common stock, commercial paper,medium-term notes, CDOs, collateralized mortgage obligations and otherborrowings. The ability to execute these strategies will depend on, among otherthings, market conditions for capital raises and for the investment of anyproceeds.

 

Pursuant to the Lease Amendment, the amount of the letter of creditconstituting our security deposit under the Lease was reduced fromapproximately $2.3 million to approximately $1.3 million. The LeaseAmendment provides for a further reduction of the amount of the letter ofcredit to $0.5 million on September 30, 2010 upon the satisfaction ofcertain conditions.

 

As we focus on growing our Investment Management segment, we expect toutilize our cash and liquidity to invest in new investment products. We alsomay use our cash in connection with the acquisition of CDO management contractsor other Investment Management opportunities. We expect a portion of our CLOsubordinated management fees to continue to be deferred in the near term. As aresult of improvement in market conditions and effective portfolio management,certain of our CLOs have returned to compliance with theirovercollateralization tests, and we have begun to recoup some of our deferredsubordinated management fees from those CLOs and expect those CLOs to payfuture subordinated management fees on a current basis.  With continuedimprovement in market conditions and ongoing effective portfolio management, weexpect our other CLOs to return to compliance with their overcollateralizationtests, and, subject to the satisfaction of certain other conditions, we wouldexpect to recoup at least a portion and potentially substantially all of ourdeferred subordinated management fees from those CLOs and to receive futuresubordinated management fees on a current basis.

 

The economic impact of our investment in DFR MM CLO is determined bythe cash flows distributed to us by DFR MM CLO on our investment in$50.0 million of preference shares and our investment in $19.0 millionof debt of DFR MM CLO, subject to diversion of cash flows away from us asprovided in accordance with the indenture for DFR MM CLO. For the three monthsended March 31, 2010 and March 31, 2009, the net income of $3.2million and $4.3 million, respectively, recorded under GAAP for DFR MM CLO isnot indicative of the cash flow distributions from DFR MM CLO of$3.8 million and $4.8 million, respectively. While cash flows fromour investment in the preference shares of DFR MM CLO were previously diverted.During the first quarter of 2010, we received a distribution of$3.6 million related to our investment in the preference shares of DFR MMCLO, and in April 2010, we received an additional $3.9 million related toour investment in the preference shares of DFR MM CLO.  While we do expect to receive future cashflows from this investment, it is very difficult to predict the timing andamount of such future cash flows.

 

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***Investment Management Segment***

 

The following is a summary of our recourse Investment Managementsegment borrowings as of March 31, 2010:

 
| ** **                                      | ** ** | **Series A and**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **Series B Notes** | ** ** |
| Outstanding  balance (in thousands)             |       | $                       | 72,453     | (1) |
| Weighted  average borrowing rate                |       | 5.75%                   |       |
| Weighted-average  remaining maturity (in years) |       | 2.75                    |       |
|                                                 |            |                         |            |  |

 

----

(1)                                  Principaloutstanding of $73.9 million is presented net of a remaining$1.5 million discount.

 

On December 21, 2007, in connection with the Merger, we issued theSeries A and Series B Notes to the sellers with a principal balanceof $73.9 million ($48.8 million Series A Notes and$25.1 million Series B Notes) recorded at carrying value of $72.4 million,net of a $1.5 million fair value discount as of March 31, 2010 thatwill be amortized into interest expense using the effective yield method fromissuance date to maturity on December 21, 2012. The Series A and Series BNotes are recourse debt. Recourse debt refers to debt that is a generalobligation.

 

On March 22, 2010,DFR and Deerfield entered into the SeniorNotes Discharge Agreement with the holders of the Senior Notes, pursuant to which wehave agreed with the holders of the Senior Notes to discharge all of theapproximately $48.8 million in aggregate principal amount of Series ANotes outstanding at approximately 64.1% of the principal amount thereof plusaccrued interest, and all of the approximately $25.1 million in aggregateprincipal amount of the Series B Notes outstanding at approximately 94.5%of the principal amount thereof plus accrued interest, or an aggregate discountof approximately 25.6% from the face amount of the Senior Notes plus accruedinterest. We are required to consummate the Senior Notes Discharge if we completeone or more debt or equity financing transactions or recapitalizationtransactions (or any combination of debt or equity financing andrecapitalization transactions), which result in cash proceeds to DFR orDeerfield in an aggregate amount of at least $25 million on or prior to July 31,2010. The issuance of the Convertible Notes would trigger this requirement. Weintend to use the proceeds of the issuance of the Convertible Notes, togetherwith other available funds, to effect the Senior Notes Discharge. Uponconsummation of the Senior Notes Discharge, all obligations and liabilities ofDFR and Deerfield under the Senior Notes will be released and the intercreditoragreement related to the Senior Notes will be terminated.

 

***Principal Investing Segment***

 

The following is a summary of our Principal Investing segmentborrowings as of March 31, 2010:

 
| ** **                                      | ** ** | **Recourse**        | ** ** | **Non-Recourse** | ** ** | ** **       |
|-------------------------------------------------|------------|---------------------|------------|------------------|------------|------------------|
| ** **                                      | ** ** | ** **          | ** ** | **Trust**        | ** ** | **Junior**       | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Repurchase**      | ** ** | **Preferred**    | ** ** | **Subordinated** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Agreements**      | ** ** | **Securities**   | ** ** | **Debt  (1)**    | ** ** | **DFR  MM CLO** | ** ** | **Total** |
| ** **                                      | ** ** | **(In  thousands)** |
| Outstanding  balance (in thousands)             |       | $                   | 277,623    |             | $          | 25,775           |   | $ | 95,000 |   | $ | 217,296 | (3) | $ | 615,694 |
| Weighted  average borrowing rate                |       | 0.31%               |       | 3.75%            |       | 1.00%            |   | 0.97% | (4) | 0.79% |
| Weighted-average  remaining maturity (in years) |       | 0.05                |       | 25.60            | (2)        | 25.60            | (1) | 9.31 |   | 8.33 |
|                                                 |            |                     |            |                  |            |                  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  On March 4,2010, $95.0 million of Trust Preferred Securities were exchanged in theExchange Agreement for $95.0 million of new Junior Subordinated Debt. TheJunior Subordinated Debt are callable by us after October 30, 2010.

 

(2)                                  The remainingTrust Preferred Securities are callable by us after October 30, 2010.

 

(3)                                  DFR MM CLOfinancing is callable after July 20, 2010 and quarterly thereafter,subject to certain conditions.

 

(4)                                  Excludes$19.0 million of DFR MM CLO debt that is owned by us and eliminated uponconsolidation. Had this debt been included, the weighted-average borrowing ratewould be 1.23%, and the weighted-average remaining maturity would have been9.31 years.

 

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*Recourse Debt*

 

Recourse debt refers to debt that is a general obligation of ours.

 

*RepurchaseAgreements*

 

As of March 31, 2010, we had borrowings via repurchase agreementstotaling $277.6 million, with a weighted-average current borrowing rate of0.31%. These borrowings were used to finance the acquisition of Agency RMBS. Weexpect to continue borrowing funds in the form of repurchase agreements.

 

As of March 31, 2010, we had outstanding repurchase agreementbalances with two financial institutions. Our repurchase agreement liabilitiesare significantly concentrated with one counterparty through which we obtainedfinancing for 86.1% of our $277.6 million of repurchase agreementliabilities as of March 31, 2010. Increases in interest rates or spreadson Agency RMBS could reduce the value of our RMBS, which could limit ourborrowing ability or cause our lenders to initiate additional margin calls. Asmost of our borrowings via repurchase agreements are short-term in nature,there is a risk that the terms presently available to us from counterparties tothese borrowing could adversely change or that counterparties could becomeunwilling to continue to provide such financing to us.

 

The following table presents certain information regarding the amountat risk related to our repurchase agreements:

 
| ** **                               | ** ** | ** **             | ** ** | ** **     | ** ** | **Weighted-Average  Maturity of Repurchase** |
|------------------------------------------|------------|------------------------|------------|----------------|------------|----------------------------------------------|
| ** **                               | ** ** | **Amount at Risk (1)** | ** ** | **Agreements** |
| ** **                               | ** ** | **March 31,**     |
| ** **                               | ** ** | **2010**               | ** ** | **2009**       | ** ** | **2010**                                     | ** ** | **2009** |
| **Repurchase Agreement Counterparties:** | ** ** | **(In thousands)**     | ** ** | **(In days)**  |
| Deutsche  Bank Securities Inc.           |       | $                      | 4,097      |           | $          | 4,990                                        |   | 8 |   | 7 |
| Fortis  Securities LLC                   |       | 4,079                  |       | 11,620         |       | 22                                           |   | 6 |
| Total                                    |       | $                      | 8,176      |           | $          | 16,610                                       |   | 20 |   | 6 |

 

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(1)                                  Equal to thefair value of securities pledged minus repurchase agreement liabilities andrelated accrued interest payable.

 

*Junior Subordinated Debtand Trust Preferred Securities*

 

On March 4,2010, we entered into the ExchangeAgreement with Taberna Preferred Funding V, Ltd., Taberna PreferredFunding VII, Ltd., Taberna Preferred Funding VIII, Ltd. andTaberna Preferred Funding IX Ltd. (collectively, “Taberna”), to exchange$95.0 million of the $120.0 million aggregate outstanding principalamount of Trust Preferred Securities previously issued by our threewholly-owned indirect subsidiaries, Deerfield Capital Trust I, DeerfieldCapital Trust II and Deerfield Capital Trust III, for$95.0 million aggregate outstanding principal amount of juniorsubordinated notes (the “JuniorSubordinated Debt”) issued by us (the “Trust Preferred Exchange”). The Trust Preferred Exchange wascompleted on March 4, 2010. An aggregate of $25.0 million inprincipal amount of Trust Preferred Securities issued by Deerfield CapitalTrust I was not exchanged and remains outstanding.

 

The JuniorSubordinated Debt is governed by a junior subordinated indenture (the “New Indenture”), dated March 4,2010, between us and The Bank of New York Mellon Trust Company, NationalAssociation, as trustee. Pursuant to the New Indenture, the Junior SubordinatedDebt bears a fixed interest rate of 1.00% per annum from the date of issuancethrough April 30, 2015 or an earlier date upon which certain specifiedevents occur (the “Modification Period”).Thereafter, the Junior Subordinated Debt will be subject to a variable interestrate equal to LIBOR plus 2.58% per annum, payable quarterly on the thenoutstanding principal amount of the Junior Subordinated Debt until maturity on October 30,2035.

 

The New Indenture contains certain restrictivecovenants including, among other things, (i) a covenant that requires allasset management activities to be conducted by DFR and its subsidiaries, andwhich permits us to sell equity and material assets of DCM only if all assetmanagement fees and proceeds from equity and asset sales are subject to thelimits on restricted payments set forth in the New Indenture, (ii) a debtcovenant that permits DFR and DCM to incur indebtedness only if the proceeds ofsuch indebtedness are subject to the limits on restricted payments set forth inthe New Indenture and (iii) a restricted payments covenant that restrictsour ability to pay dividends or make distributions in respect of our equity

 

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securities, subject to a number of exceptions and conditions. If wefail to complete one or more transactions that in the aggregate result in therepayment or refinancing of the Senior Notes upon terms that improve the creditposition of the holders of the Junior Subordinated Debt by satisfying all ofthe following conditions: (i) increased pro forma interest coverage; (ii) reducedpro forma debt-to-equity ratio; (iii) the aggregate principal amount ofany permitted refinancing indebtedness under the New Indenture is less than theaggregate principal amount of the Senior Notes; and (iv) after suchtransaction(s), the pro forma GAAP consolidated net worth of DFR is eitherpositive or has improved (a “CreditEnhancing Transaction”) within certain time periods, then theModification Period will terminate and certain exceptions to the restrictedpayments covenant will no longer be available to us. We currently expect thatthe issuance of the Convertible Notes and consummation of the Senior NotesDischarge will satisfy the requirement that we complete a Credit EnhancingTransaction. Unlike the indentures for the Trust PreferredSecurities, the New Indenture does not contain a covenant requiring us tomaintain a minimum net worth.

 

*Non-Recourse Debt*

 

Non-recourse debt refers to debt with recourse only to specific assetspledged as collateral to the lenders. The creditors of the non-recourse debthave no recourse to our other assets. None of the long term debt is subject topotential margin calls for additional pledges of our cash or assets.

 

*DFR MM CLO*

 

TheDFR MM CLO notes are due in 2019, but are callable by us, at par, on July 20,2010 and quarterly thereafter, subject to certain conditions. DFR MM CLO is aconsolidated bankruptcy remote subsidiary, and the holders of its debtsecurities have recourse only to the collateral of DFR MM CLO, which had assetswith a carrying value of $280.0 million as of March 31, 2010. Duringthe three months ended March 31, 2010, DFR MM CLO paid down$13.7 million of its outstanding debt as a result of certain structuralprovisions contained in its indenture.

 

***Consolidated Investment Products Segment***

 

The following is a summary of our Consolidated Investment Productssegment borrowings as of March 31, 2010:

 
| ** **                                      | ** ** | **Non-recourse**   | ** ** |
|-------------------------------------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **long term debt** | ** ** |
| Outstanding  balance (in millions)              |       | $                  | 2,512      | (1) |
| Weighted  average borrowing rate                |       | 0.82%              |       |
| Weighted-average  remaining maturity (in years) |       | 9.1                |       |
|                                                 |            |                    |            |  |

 

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(1)                                  All the debt inthe Consolidated Investment Products segment is non-recourse debt as the investors in the CIP CDOs have norecourse to our general credit for the notes issued by the CIP CDOs. Wetherefore do not consider this debt to be an obligation of ours.

 

***Distribution Policy***

 

We are no longer subject to the distribution requirements applicable toREITs. The covenants contained in our indebtedness currently prohibit us fromdeclaring dividends or distributions on our common stock, and therefore, we donot expect to make dividend distributions in the foreseeable future.

 

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**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

As of March 31, 2010, the primary component of our market risk wasinterest rate and spread risk, as described below. While we do not seek toavoid risk completely, we manage interest rate risk and regularly assesswhether earnings in our portfolio include appropriate compensation for theinherent market risks to which it is exposed. In light of these risks, weregularly consider our capital levels and currently are focused on redeployingcapital from Principal Investing activities to growing our InvestmentManagement segment.

 

**Interest Rate Risk**

 

We are subject to interest rate risk primarily in connection with ourinvestments in hybrid adjustable-rate and fixed-rate RMBS and our debtobligations related to those investments, which are generally repurchaseagreements of short duration that periodically reset at current market rates.We seek to manage this risk through utilization of derivative contracts,primarily interest rate swap agreements and futures contracts on U.S. Treasurysecurities.

 

**Effect on Net Interest Income**

 

We fund our investments in RMBS primarily with short term borrowingsunder repurchase agreements. During periods of rising interest rates, shortterm borrowing costs tend to increase while the income earned on hybridadjustable-rate (during the fixed-rate period of such securities) and fixed-rateRMBS may remain substantially unchanged. When this happens, the result is anarrowing of the net interest spread between the related assets and borrowingsand may even result in losses.

 

In order to assist in mitigating our interest rate exposure, we haveone interest rate swap transaction outstanding as of March 31, 2010 with anotional value of $10.0 million which expires during 2010.

 

Our hedging strategies are partly based on assumed levels ofprepayments of our RMBS. If prepayments are slower or faster than assumed, thelife of the RMBS will be longer or shorter, which changes the net impact of ourhedging activity and may cause unexpected gains or losses on such transactions.Hedging strategies involving the use of derivative instruments are highlycomplex and may produce volatile returns.

 

**Extension Risk**

 

The majority of our RMBS portfolio consists of hybrid adjustable-rateRMBS, which have interest rates that are fixed for the first several years ofthe loan (typically three, five, seven or 10 years) and, thereafter, resetperiodically on the same basis as adjustable-rate RMBS. We compute theprojected weighted-average life of our RMBS based on assumptions regarding therate at which the borrowers will prepay the underlying mortgages. In general,when a fixed-rate or hybrid adjustable-rate RMBS is funded by a short termborrowing, we may, but are not required to, enter into an interest rate swapagreement or other hedging instrument that effectively fixes a portion of ourborrowing costs for a period close to the anticipated weighted-average life ofthe fixed-rate portion of the related RMBS. This strategy is designed toprotect a portion of our portfolio from increased funding costs due to risinginterest rates because the borrowing costs are not fixed for the duration ofthe fixed-rate period of the related RMBS.

 

However, if prepayment rates decrease in a rising interest rateenvironment, the weighted average life of the fixed-rate portion of the relatedRMBS could extend beyond the term of the swap agreement or other hedginginstrument. This could have a negative impact on our results of operations, asborrowing costs would no longer be effectively fixed after the maturity of thehedging instrument, while the income earned on the remaining hybridadjustable-rate RMBS would remain fixed for a period of time. This situationmay also cause the market value of our hybrid adjustable-rate RMBS to decline,with little or no offsetting gain from the related hedging transactions. We maybe forced to sell assets to maintain adequate liquidity, which could cause usto incur losses, and we may be unable to sell assets on favorable terms or atall.

 

**Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk**

 

We also invest in hybrid adjustable-rate RMBS which are based onmortgages that are typically subject to periodic and lifetime interest ratecaps and floors, which limit the amount by which the security’s interest ratemay change during any given period. However, our borrowing costs pursuant toour repurchase agreements will not be subject to similar restrictions.Therefore, in a period of increasing interest rates, interest rate costs on ourborrowings could increase without limitation by caps, while the interest-rateyields on our hybrid adjustable-rate RMBS could be limited by caps. Thesefactors could lower our net interest income or cause a net loss during periodsof rising interest rates, which would negatively impact our financialcondition, cash flows and results of operations.

 

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**Interest Rate Mismatch Risk**

 

We intend to fund a substantial portion of our purchases of RMBS withborrowings that, after the effect of hedging, have interest rates based onindices and repricing terms similar to, but of somewhat shorter maturitiesthan, the interest rate indices and repricing terms of the RMBS. Thus, weanticipate that in most cases the interest rate indices and repricing terms ofour RMBS and our funding sources will not be identical, thereby creating aninterest rate mismatch between assets and liabilities. Therefore, our cost offunds would likely rise or fall more quickly than would our earnings rate onassets. During periods of changing interest rates, such interest ratemismatches could negatively impact our financial condition, cash flows andresults of operations. To mitigate interest rate mismatches, we may utilizehedging strategies discussed above.

 

Our analysis of portfolio risks is based on management’s experience,estimates, quantitative analysis and assumptions. These analyses rely onmodels, which utilize estimates of fair value and interest rate sensitivity.Actual economic conditions or implementation of investment decisions by ourmanagement may produce results that differ significantly from the estimates andassumptions used in our models and the projected results reflected herein.

 

**Prepayment Risk**

 

Prepayments are the full or partial repayments of principal prior tocontractual due dates of mortgage loans and often occur due to refinancingactivity. Prepayment rates for existing RMBS generally increase when prevailinginterest rates fall below the market rate existing when the underlyingmortgages were originated. In addition, prepayment rates on adjustable-rate andhybrid adjustable-rate RMBS generally increase when the spread betweenlong-term and short-term interest rates declines or becomes negative.Prepayments of RMBS could impact our results of operations in several ways.Some adjustable-rate mortgages underlying our adjustable-rate RMBS may bearinitial teaser interest rates that are lower than their fully-indexed rates,which refers to the applicable index rates plus a spread. In the event that suchan adjustable-rate mortgage is prepaid prior to or soon after the time ofadjustment to a fully-indexed rate, the holder of the related RMBS would haveheld such security while it was less profitable and lost the opportunity toreceive interest at the fully-indexed rate over the expected life of theadjustable-rate RMBS. Additionally, we currently own RMBS that were purchasedat a premium. The prepayment of such RMBS at a rate faster than anticipatedwould result in a write-off of any remaining unamortized premium and acorresponding reduction of our net interest income by such amount.

 

**Effect on Fair Value**

 

Another component of interest rate risk is the effect changes ininterest rates will have on the fair value of our assets. We face the risk thatthe fair value of our assets will increase or decrease at different rates thanthat of our liabilities, including our hedging instruments.

 

We primarily assess our interest rate risk by estimating the durationof our assets and the duration of our liabilities. Duration essentiallymeasures the market price volatility of financial instruments as a function ofinterest rates changes. We calculate duration using various third partyfinancial models and empirical data. Different models and methodologies canproduce different duration numbers for the same securities.

 

The following sensitivity analysis table shows the impact on theestimated fair value of our RMBS interest rate-sensitive investments andinterest rate swaps as of March 31, 2010, assuming rates instantaneouslyfall 100 basis points and rise 100 basis points. The below table excludes thesecurities held in DFR MM CLO and the CIP CDOs because these investments areimpacted by cash flows and the terms of their respective indentures, ratherthan fair values.

 

 
| ** **                         | ** ** | **Interest Rates**         | ** ** | ** **    | ** ** | **Interest Rates** |
|------------------------------------|------------|----------------------------|------------|---------------|------------|--------------------|
| ** **                         | ** ** | **Fall 100**               | ** ** | ** **    | ** ** | **Rise 100**       |
| ** **                         | ** ** | **Basis Points**           | ** ** | **Unchanged** | ** ** | **Basis Points**   |
| ** **                         | ** ** | **(Dollars in thousands)** |
| **RMBS**                           |       |                       |       |          |       |               |
| Fair  value                        |       | $                          | 306,265    |          | $          | 303,258            |   | $ | 296,020 |
| Change  in fair value              |       | $                          | 3,007      |          |       |               | $ | (7,238) |
| Change  as a percent of fair value |       | 0.99%                      |       |          |       | -2.39%             |
| **Interest Rate Swaps**            |       |                       |       |          |       |               |
| Fair  value                        |       | $                          | (201)      |          | $          | (197)              |   | $ | (171) |
| Change  in fair value              |       | $                          | (4)        |          |       |               | $ | 26 |
| Change  as a percent of fair value |       | -1.93%                     |       |          |       | 13.07%             |
| **Net Portfolio Impact**           |       | $                          | 3,003      |          |       |               | $ | (7,212) |

 

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The impact of changing interest rates on fair value can changesignificantly when interest rates change beyond 100 basis points from current levels.Therefore, the volatility in the fair value of our assets could increasesignificantly when interest rate changes exceed 100 basis points. In addition,other factors impact the fair value of our interest rate-sensitive investmentsand hedging instruments, such as the shape of the yield curve, marketexpectations as to future interest rate changes and other market conditions.Accordingly, in the event of changes in actual interest rates, the change inthe fair value of our assets would likely differ from that shown above and suchdifference might be material and adverse to our stockholders.

 

As of March 31, 2010, substantially all investments in ouralternative investments portfolio (non-RMBS) are instruments with variableinterest rates that are indexed to LIBOR. Because the variable rates on theseinstruments are short term in nature, we are not exposed to material changes infair value as a result of changes in interest rates.

 

**Risk Management**

 

We look at investment risk across all of our products specifically asit relates to the product’s target returns or asset/liability managementframework. We believe that in order to achieve long-term investment performanceconsistent with our clients’ expectations, we need an understanding of theinvestment risks taken, or proposed to be taken, in each portfolio relative tothe corresponding liability and return profile, as well as those risks inherentin the increasingly complex global capital markets. Our risk management processemphasizes trading system and data integrity, counterparty creditworthiness,adherence to investment guidelines and client communication.

 

We employ active risk monitoring for both our portfolio management andoperational activities within the business. Our risk management program seeksto address not only the risks of unexpected portfolio losses, but also theoperational risks that can have major adverse impacts on our business results.Portfolio risks include, for example, potential losses due to price volatility,position sizing and leverage. Operational risks include, for example,settlement and clearing of transactions, properly recording and valuingpositions, supervision of traders, counterparty credit monitoring and approval,custodian reconciliations, trader authorization, accounting and regulatory.

 

Our risk management committee meets at regular intervals to ensure wehave properly identified the risks inherent in the operation of our business,formulated and approved policies and procedures to mitigate the identifiedrisks, monitor overall adherence to the policies and report to management anysignificant concerns regarding the adequacy of procedures, systems or personnelin the conduct of our business.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

Pursuant to Rule 13a-15(b) under the Securities Exchange Actof 1934, as amended, or the Exchange Act, we carried out an evaluation, withthe participation of our management, including our Chief Executive Officer andour Senior Vice President, Chief Financial Officer and Treasurer, of theeffectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) underthe Exchange Act), as of the end of the period covered by this Annual Report.Based upon that evaluation, our Chief Executive Officer and our Senior VicePresident, Chief Financial Officer and Treasurer concluded that our disclosurecontrols and procedures are effective.

 

**Change in Internal Control Over Financial Reporting**

 

There have been no changes in our internal control over financialreporting during the three months ended March 31, 2010 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Inherent Limitations on Effectiveness of Controls**

 

There are inherent limitations in the effectiveness of any controlsystem, including the potential for human error and the circumvention oroverriding of the controls and procedures. Additionally, judgments indecision-making can be faulty and breakdowns can occur because of simple erroror mistake. An effective control system can provide only reasonable, notabsolute, assurance that the control objectives of the system are adequatelymet. Accordingly, our management, including our Chief Executive Officer and ourSenior Vice President, Chief Financial Officer and Treasurer do not expect thatour control system can prevent or detect all errors or fraud. Finally,projections of any evaluation or assessment of effectiveness of a controlsystem to future periods are subject to the risks that, over time, controls maybecome inadequate because of changes in an entity’s operating environment ordeterioration in the degree of compliance with policies or procedures.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1A.  RISKFACTORS**

 

Therehave not been any material changes from the risk factors disclosed in *“Part I — Item 1A. Risk Factors”* ofour 2009 10-K.

 

**ITEM 5. OTHER INFORMATION**

 

On May 11, 2010, Francis P. Straub III, our Senior Vice President,Chief Financial Officer and Treasurer, tendered his resignation effective May 28,2010.  Mr. Straub’s resignation was not due to any dispute or disagreementwith the Company or its Board or management.

 

**ITEM 6. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

 
| **Exhibit. No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                   |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Acquisition  and Investment Agreement, dated as of March 22, 2010, by and between  Deerfield Capital Corp., Bounty Investments, LLC and Columbus Nova  Credit Investment Management, LLC.(1)                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 3.1              |       | Articles  of Amendment and Restatement of Deerfield Capital Corp., as amended and  supplemented.(2)                                                                                                                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 4.1              |       | Senior  Subordinated Convertible Notes Agreement, dated as of March 22, 2010, by  and between Deerfield Capital Corp. and Bounty Investments, LLC.(1)                                                                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 4.2              |       | Junior  Subordinated Indenture, dated March 4, 2010, by and between Deerfield  Capital Corp. and The Bank of New York Mellon Trust Company, National  Association, as Trustee.(3)                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.1             |       | Exchange  Agreement among Deerfield Capital Corp., Taberna Preferred Funding V., Ltd.,  Taberna Preferred Funding VII, Ltd., Taberna Preferred Funding VIII, Ltd.,  and Taberna Preferred Funding IX, Ltd., dated as of March 4, 2010.(3)                                                               |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.2             |       | Agreement  between Deerfield Capital Corp. and Peter Rothschild, dated as of  March 22, 2010.(4)                                                                                                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.3             |       | Form of  Stockholders Agreement between Deerfield Capital Corp. and Bounty  Investments, LLC.(1)                                                                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.4             |       | Payment  Agreement and Release, dated as of March 22, 2010, by and among  Deerfield & Company LLC, Deerfield Capital Corp., each of the  holders listed therein, Wendy’s/Arby’s Group, Inc. and Spensyd Asset  Management LLLP.(1)                                         |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.5             |       | Transition  Services Agreement, dated as of March 22, 2010, by among Deerfield  Capital Corp., Bounty Investments, LLC and Columbus Nova Credit  Investment Management, LLC.(1)                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.6             |       | Form of  Registration Rights Agreement by and among Deerfield Capital Corp. and Bounty  Investments, LLC.(1)                                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 10.7             |       | Waiver  and Termination Agreement, dated as of March 21, 2010, among Pegasus  Deerfield (AIV), LLC, PGS Management, LLC, the Company, Deerfield  Capital Management, LLC, DPLC General Partner LLC, Deerfield Loan  Manager LLC and Deerfield Pegasus Loan Capital LP.(1) |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 31.1             |       | Certification  of Principal Executive Officer Pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.*                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 31.2             |       | Certification  of Principal Financial Officer Pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.*                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                         |
| 32.1             |       | Certification  of Principal Executive Officer and Principal Financial Officer pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.*                                                                                                         |

 

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*                                         Filed herewith.

 

(1)                                  Incorporated byreference to the Company’s Current Report on Form 8-K filed with the SECon March 23, 2010.

 

(2)                                Incorporated byreference to the Company’s Quarterly Report on Form 10-Q for the quarterlyperiod ended June 30, 2009, filed with the SEC on August 10, 2009.

 

(3)                                  Incorporated byreference to the Company’s Current Report on Form 8-K filed with the SECon March 10, 2010.

 

(4)                                  Incorporated byreference to the Company’s Annual Report on Form 10-K for the year ended December 31,2009.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                     | DEERFIELD CAPITAL CORP.                                   |
|--------------------------|-----------------------------------------------------------|
|                     | (Registrant)                                              |
|                     |                                                      |
|                     |                                                      |
| Date:  May 17, 2010 | By: /s/ Jonathan W. Trutter                               |
|                     | Jonathan W. Trutter, Chief Executive Officer and Director |
|                     | (Principal Executive Officer)                             |
|                     |                                                      |
| Date:  May 17, 2010 | By: /s/ Francis P. Straub III                             |
|                     | Francis P. Straub III, Senior Vice President,             |
|                     | Chief Financial Officer and Treasurer                     |
|                     | (Principal Financial and Accounting Officer)              |

 

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