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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2008
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number: 1-32551
 DEERFIELD CAPITAL CORP.
  Maryland
    
    20-2008622(State of incorporation)
    
    (I.R.S. EmployerIdentification No.)
 6250 North River Road, 9th Floor, Rosemont, Illinois 60018
(773) 380-1600
 þ o
  Large accelerated filer þ

   

   Accelerated filer
 o


   Non-accelerated filer o
(Do not check if a smaller reporting company)


  Smaller reporting company o
 o þ




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##### 



DEERFIELD CAPITAL CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2008
INDEX
 PagePart
I. Financial InformationItem 1.
Condensed Consolidated Financial Statements and Notes (Unaudited)
    
    
    7Condensed Consolidated Balance Sheets  September 30, 2008 and December 31, 2007
    
    
    7Condensed Consolidated Statements of Operations  Three and Nine Months Ended September 30, 2008 and 2007
    
    
    8Condensed Consolidated Statement of Stockholders Equity  Nine Months Ended September 30, 2008
    
    
    9Condensed Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2008 and 2007
    
    
    10Notes to Condensed Consolidated Financial Statements
    
    
    12Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    45Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    94Item 4. Controls and Procedures
    
    
    97Part II. Other InformationItem 1A. Risk Factors
    
    
    99Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    103Item 5. Other Information
    
    
    104Item 6. Exhibits
    
    
    104Signatures
    
    
    105EX-3.1EX-10.1EX-10.2EX-31.1EX-31.2EX-32.1
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
   Relating to our business generally:
 
    
    the expected delisting of our common stock by the New York Stock Exchange (the NYSE) and the potential
that we may be unable to obtain a listing for our common stock on an alternative national securities exchange;
    
    effects of our potential inability to list our common stock on a national securities exchange on our access to equity
and debt capital and on the liquidity and value of our common stock;
    
    actual financial results may be materially different than any projections or estimates;
    
    effects of the current dislocation in the subprime mortgage sector and the weakness in
the mortgage market and credit markets generally;
    
    effects of the current global economic crisis and anticipated recession;
    
    rapid changes in market value of and/or sales of residential mortgage-backed securities
(RMBS) and other assets, making it difficult for us to maintain our current or any
alternative exemption from registration under the Investment Company Act of 1940, as
amended (the 1940 Act) before March 2009, when the temporary exemption on which we are
currently relying expires;
    
    failure to comply with covenants contained in the agreements governing our
indebtedness, including our ability to receive waivers for any non-compliance;
    
    limitations and restrictions contained in instruments and agreements governing our
indebtedness;
    
    ability to maintain adequate liquidity, including ability to raise additional capital
and secure additional financing;
    
    increases in borrowing costs relative to interest received on assets;
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
    
    the costs and effects of the current Securities and Exchange Commission (SEC)
investigation into certain mortgage securities trading procedures in connection with which
the SEC has requested information from Deerfield Capital Corp. (DFR) and Deerfield
Capital Management LLC (DCM) regarding certain mortgage securities trades of ours;
    
    changes in investment strategy;
    
    ability to continue to issue collateralized debt obligation (CDO) vehicles, which can
provide us with financing for debt securities investments;
    
    effects of CDO financings on cash flows;
    
    loss of key personnel, most of whom are not bound by employment agreements;
    
    effects of any potential strategic transaction:
    
    adverse changes in accounting principles, tax law, or legal/regulatory requirements;
    
    failure to comply with applicable laws and regulations;
    
    liability resulting from actual or potential future litigation;
    
    the costs, uncertainties and other effects of legal and administrative proceedings;
    
    the costs of obtaining, and the potential inability to obtain, necessary or prudent
insurance to cover our business operations;
    
    the impact of competition;
    
    actions of domestic and foreign governments and the effect of war or terrorist
activity; and
    
    our ability to forecast our tax attributes, which are based upon various facts and
assumptions, and our ability to protect and use our net operating losses to offset taxable
income.
 Relating to the Investment Management segment:
 
    
    continued significant reductions in assets under management (AUM), which would reduce
our investment advisory fee revenue, due to such factors as weak investment performance,
substantial illiquidity or price volatility in the fixed income instruments in which we
trade, loss of key portfolio management or other personnel (or lack of availability of
additional key personnel if needed for expansion), reduced investor demand for the types of
investment products that we offer or loss of investor confidence due to weak investment
performance, volatility of returns, general declines in economic conditions and adverse
publicity;
    
    significant reductions in our AUM resulting from withdrawal of money from separately
managed accounts;
    
    significant reductions in investment advisory fees and/or AUM resulting from the
failure to satisfy certain structural protections and/or the triggering of events of
default contained in the indentures governing the CDOs;
    
    non-renewal or early termination of investment management agreements or removal of DCM
as investment manager pursuant to the terms of such investment management agreements;
    
    pricing pressure on the advisory fees that we can charge for our investment advisory
services;
    
    difficulty in increasing AUM, or efficiently managing existing assets, due to
market-related constraints on trading capacity, inability to hire the necessary additional
personnel or lack of potentially profitable trading opportunities;
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
    
    the reduction in CDO management fees or AUM resulting from payment defaults by issuers
of the underlying collateral, downgrades of the underlying collateral by the rating
agencies or depressed market values of the underlying collateral, all of which may
contribute to the triggering of certain structural protections built into CDOs;
    
    changes in CDO asset and liability spreads making it difficult or impossible to launch
new CDOs or negatively impacting our investment advisory fees;
    
    liability relating to our failure to comply with investment guidelines set by our
clients or the provisions of the management and other agreements; and
    
    changes in laws, regulations or government policies affecting our business, including
investment management regulations and accounting standards.
 Relating to the Principal Investing segment:
 
    
    impact of changes in our strategy surrounding the composition of our investment
portfolio;
    
    widening of mortgage spreads relative to swaps or treasuries leading to a decrease in
the value of our mortgage portfolio resulting in higher counterparty margin calls and
decreased liquidity;
    
    effects of leverage and indebtedness on portfolio performance;
    
    effects of defaults or terminations under repurchase transactions, interest rate swaps
and long-term debt obligations;
    
    effects of having the majority of our repurchase transactions concentrated with one
counterparty;
    
    higher or lower than expected prepayment rates on the mortgages underlying our RMBS
portfolio;
    
    illiquid nature of certain of the assets in our investment portfolio;
    
    increased rates of default on our investment portfolio (which risk rises as the
portfolio seasons) and decreased recovery rates on defaulted loans;
    
    our inability to obtain favorable interest rates, margin or other terms on the
financing that is needed to leverage our RMBS and other positions;
    
    flattening or inversion of the yield curve (short term interest rates increasing at a
greater rate than longer term rates), reducing our net interest income on our financed
mortgage securities positions;
    
    our inability to adequately hedge our holdings sensitive to changes in interest rates;
    
    narrowing of credit spreads, thus decreasing our net interest income on future credit
investments (such as bank loans);
    
    concentration of investment portfolio in adjustable-rate RMBS;
    
    effects of investing in equity and mezzanine securities of CDOs; and
    
    effects of investing in the debt of middle market companies.
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Relating to the Merger:
 
    
    continued inability to realize the economic benefits that DFR anticipated as a result
of its acquisition of Deerfield & Company LLC (the Merger);
    
    failure to uncover all risks and liabilities associated with acquiring DCM;
    
    the impact of owning DCM on DFRs ability to rely on an exemption from registration
under the 1940 Act; and
    
    the impact of approximately $74 million of two series of senior secured notes issued as
parties consideration for the Merger and DFRs guarantee of those notes, including the
impact of DFRs guarantee of those notes on DFRs liquidity, ability to raise additional
capital and financial condition.
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Part I.
FINANCIAL INFORMATION   ITEM 1. Financial Statements
 DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 September 30,
    
    
    December 31,2008
    
    
    2007(In thousands, except shareand per share amounts)ASSETSCash and cash equivalents
    
    $
    41,908
    
    
    $
    113,733Due from broker
    
    
    12,715
    
    
    
    270,630Restricted cash and cash equivalents
    
    
    63,034
    
    
    
    47,125Available-for-sale securities, including zero and $4,884,023 pledgedat fair value
    
    
    5,078
    
    
    
    4,897,972Trading securities, including $408,660 and $733,782 pledgedat fair value
    
    
    415,462
    
    
    
    1,444,505Other investments
    
    
    4,764
    
    
    
    5,472Derivative assets
    
    
    2,004
    
    
    
    4,537Loans held for sale
    
    
    267,419
    
    
    
    267,335Loans
    
    
    356,709
    
    
    
    466,360Allowance for loan losses
    
    
    (21,596
    )
    
    
    (5,300
    )Loans, net of allowance for loan losses
    
    
    335,113
    
    
    
    461,060Investment advisory fee receivables
    
    
    4,077
    
    
    
    6,409Interest receivable
    
    
    7,804
    
    
    
    39,216Other receivable
    
    
    3,131
    
    
    
    22,912Prepaid and other assets
    
    
    12,911
    
    
    
    14,721Fixed assets, net
    
    
    9,470
    
    
    
    10,447Intangible assets, net
    
    
    36,364
    
    
    
    83,225Goodwill
    
    
    
    
    
    
    98,670TOTAL ASSETS
    
    $
    1,221,254
    
    
    $
    7,787,969LIABILITIESRepurchase agreements, including $336 and $20,528 of accrued interest
    
    $
    383,617
    
    
    $
    5,303,865Due to broker
    
    
    2,298
    
    
    
    879,215Dividends payable
    
    
    7,354
    
    
    
    21,944Derivative liabilities
    
    
    7,927
    
    
    
    156,813Interest payable
    
    
    4,901
    
    
    
    28,683Accrued and other liabilities
    
    
    15,209
    
    
    
    35,652Short term debt
    
    
    172
    
    
    
    1,693Long term debt
    
    
    736,408
    
    
    
    775,368TOTAL LIABILITIES
    
    
    1,157,886
    
    
    
    7,203,233Series A cumulative convertible preferred stock; $0.001 par value, zero shares and
14,999,999
shares issued and outstanding (aggregate liquidation value of zero and $150,000)
    
    
    
    
    
    
    116,162STOCKHOLDERS EQUITYPreferred stock, par value $0.001:100,000,000 shares authorized; zero and 14,999,992 shares issued and outstanding
as described above
    
    
    
    
    
    
    Common stock, par value $0.001:500,000,000 shares authorized; 6,676,106 and 5,175,272 shares issued and
6,669,742 and 5,165,532 shares outstanding
    
    
    7
    
    
    
    5Additional paid-in capital
    
    
    866,330
    
    
    
    748,262Accumulated other comprehensive loss
    
    
    (1,525
    )
    
    
    (83,783
    )Accumulated deficit
    
    
    (801,444
    )
    
    
    (195,910
    )TOTAL STOCKHOLDERS EQUITY
    
    
    63,368
    
    
    
    468,574TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    1,221,254
    
    
    $
    7,787,969
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands, except share and per share amounts)RevenuesInterest income
    
    $
    20,506
    
    
    $
    125,765
    
    
    $
    103,680
    
    
    $
    378,176Interest expense
    
    
    11,671
    
    
    
    98,948
    
    
    
    71,692
    
    
    
    300,346Net interest income
    
    
    8,835
    
    
    
    26,817
    
    
    
    31,988
    
    
    
    77,830Provision for loan losses
    
    
    15,459
    
    
    
    
    
    
    
    19,961
    
    
    
    6,933Net interest (expense) income after
provision for loan losses
    
    
    (6,624
    )
    
    
    26,817
    
    
    
    12,027
    
    
    
    70,897Investment advisory fees
    
    
    9,015
    
    
    
    
    
    
    
    33,493
    
    
    
    Total net revenues
    
    
    2,391
    
    
    
    26,817
    
    
    
    45,520
    
    
    
    70,897ExpensesManagement fee expense to related party
    
    
    
    
    
    
    2,710
    
    
    
    
    
    
    
    9,470Incentive fee expense to related party
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,185Compensation and benefits
    
    
    4,982
    
    
    
    
    
    
    
    22,045
    
    
    
    Depreciation and amortization
    
    
    2,498
    
    
    
    
    
    
    
    7,765
    
    
    
    Professional services
    
    
    2,211
    
    
    
    1,418
    
    
    
    5,941
    
    
    
    2,835Insurance expense
    
    
    740
    
    
    
    207
    
    
    
    2,207
    
    
    
    548Other general and administrative expenses
    
    
    2,062
    
    
    
    721
    
    
    
    6,572
    
    
    
    1,881Impairment of intangible assets and goodwill
    
    
    110,268
    
    
    
    
    
    
    
    139,302
    
    
    
    Total expenses
    
    
    122,761
    
    
    
    5,056
    
    
    
    183,832
    
    
    
    16,919Other Income and Gain (Loss)Net loss on available-for-sale securities
    
    
    (856
    )
    
    
    (23,176
    )
    
    
    (4,712
    )
    
    
    (20,870
    )Net (loss) gain on trading securities
    
    
    (13,655
    )
    
    
    5,645
    
    
    
    (216,121
    )
    
    
    2,597Net loss on loans and loans held for sale
    
    
    (14,367
    )
    
    
    (7,451
    )
    
    
    (35,404
    )
    
    
    (6,981
    )Net loss on derivatives
    
    
    (2,239
    )
    
    
    (20,216
    )
    
    
    (219,384
    )
    
    
    (14,843
    )Dividend income and other net loss
    
    
    (678
    )
    
    
    (118
    )
    
    
    (484
    )
    
    
    (215
    )Net other income and (loss) gain
    
    
    (31,795
    )
    
    
    (45,316
    )
    
    
    (476,105
    )
    
    
    (40,312
    )(Loss) income before income tax expense (benefit)
    
    
    (152,165
    )
    
    
    (23,555
    )
    
    
    (614,417
    )
    
    
    13,666Income tax expense (benefit)
    
    
    4,718
    
    
    
    (320
    )
    
    
    384
    
    
    
    (120
    )Net (loss) income
    
    $
    (156,883
    )
    
    $
    (23,235
    )
    
    $
    (614,801
    )
    
    $
    13,786NET (LOSS) INCOME PER SHARE  BASIC
    
    $
    (22.81
    )
    
    $
    (4.50
    )
    
    $
    (95.52
    )
    
    $
    2.67NET (LOSS) INCOME PER SHARE  DILUTED
    
    $
    (22.81
    )
    
    $
    (4.50
    )
    
    $
    (95.52
    )
    
    $
    2.67WEIGHTED-AVERAGE NUMBER OF SHARES

OUTSTANDING  BASIC
    
    
    6,878,260
    
    
    
    5,161,811
    
    
    
    6,436,583
    
    
    
    5,160,089WEIGHTED-AVERAGE NUMBER OF SHARES

OUTSTANDING  DILUTED
    
    
    6,878,260
    
    
    
    5,161,811
    
    
    
    6,436,583
    
    
    
    5,170,557
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (UNAUDITED)
 AccumulatedCommon Stock
    
    
    Additional
    
    
    OtherPar
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Accumulated
    
    
    
    
    
    
    ComprehensiveShares
    
    
    Value
    
    
    Capital
    
    
    Loss
    
    
    Deficit
    
    
    Total
    
    
    Loss(In thousands)Balance  December 31, 2007
    
    
    5,166
    
    
    $
    5
    
    
    $
    748,262
    
    
    $
    (83,783
    )
    
    $
    (195,910
    )
    
    $
    468,574Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (614,801
    )
    
    
    (614,801
    )
    
    $
    (614,801
    )Cumulative effect adjustment from the
adoption of SFAS No. 159
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,914
    )
    
    
    14,914
    
    
    
    Available-for-sale securities  fair value adjustment
net of reclassification adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    178
    
    
    
    
    
    
    
    178
    
    
    
    178Previously designated derivatives  amortization
of net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    96,996
    
    
    
    
    
    
    
    96,996
    
    
    
    96,996Foreign currency translation loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )
    
    
    (2
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (517,629
    )Conversion of Series A cumulative convertible
preferred stock
into common stock
    
    
    1,500
    
    
    
    2
    
    
    
    117,163
    
    
    
    
    
    
    
    
    
    
    
    117,165Share-based compensation
    
    
    4
    
    
    
    
    
    
    
    3,298
    
    
    
    
    
    
    
    
    
    
    
    3,298Dividends declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,647
    )
    
    
    (5,647
    )Preferred stock dividend and accretion
    
    
    
    
    
    
    
    
    
    
    (2,393
    )
    
    
    
    
    
    
    
    
    
    
    (2,393
    )Balance  September 30, 2008
    
    
    6,670
    
    
    $
    7
    
    
    $
    866,330
    
    
    $
    (1,525
    )
    
    $
    (801,444
    )
    
    $
    63,368
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Nine months ended September 30,2008
    
    
    2007(In thousands)CASH FLOWS FROM OPERATING ACTIVITIES:Net (loss) income
    
    $
    (614,801
    )
    
    $
    13,786Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:Net premium and discount amortization on investments, loans and debt issuance
    
    
    2,286
    
    
    
    19,159Share-based compensation
    
    
    508
    
    
    
    214Hedge ineffectiveness
    
    
    
    
    
    
    1,088Net (purchases) sales of trading securities
    
    
    658,244
    
    
    
    (721,301
    )Net loss (gain) from trading securities
    
    
    216,121
    
    
    
    (2,597
    )Other-than-temporary impairment on available-for-sale securities
    
    
    4,735
    
    
    
    16,567Net loss on other investments
    
    
    708
    
    
    
    449Net (purchases) proceeds on loans held for sale
    
    
    (9,349
    )
    
    
    13,965Net loss on loans and loans held for sale
    
    
    35,416
    
    
    
    7,061Provision for loan losses
    
    
    19,961
    
    
    
    6,933Net realized (gain) loss on available-for-sale securities
    
    
    (23
    )
    
    
    4,303Net changes in undesignated derivatives
    
    
    (159,032
    )
    
    
    19,753Amortization of net loss (gain) on previously designated derivatives
    
    
    96,996
    
    
    
    (15,756
    )Net cash paid on terminated designated derivatives
    
    
    
    
    
    
    (7,554
    )Depreciation and amortization
    
    
    7,765
    
    
    
    Impairment of intangible assets and goodwill
    
    
    139,302
    
    
    
    Non-cash rental expense
    
    
    149
    
    
    
    Deferred tax benefit
    
    
    384
    
    
    
    Changes in operating assets and liabilities:Due from broker
    
    
    98,278
    
    
    
    16,706Interest receivable
    
    
    25,400
    
    
    
    (230
    )Other receivable
    
    
    1,842
    
    
    
    607Prepaid and other assets
    
    
    (103
    )
    
    
    (6,887
    )Accrued interest on repurchase agreements
    
    
    (20,192
    )
    
    
    (10,669
    )Due to broker
    
    
    (1,516
    )
    
    
    (21,685
    )Interest payable
    
    
    (8,794
    )
    
    
    12,822Management and incentive fee payable to related party
    
    
    
    
    
    
    (41
    )Accrued and other liabilities
    
    
    (19,892
    )
    
    
    (1,038
    )Net cash
provided by (used in) operating activities
    
    
    474,393
    
    
    
    (654,345
    )CASH FLOWS FROM INVESTING ACTIVITIES:Change in restricted cash and cash equivalents
    
    
    (15,909
    )
    
    
    (17,587
    )Purchase of available-for-sale securities
    
    
    (2,378
    )
    
    
    (1,665,665
    )Proceeds from the sale of available-for-sale securities
    
    
    
    
    
    
    1,948,759Principal payments on available-for-sale securities
    
    
    25,916
    
    
    
    1,060,848Proceeds from the sale of trading securities previously classified as available-for-sale
    
    
    4,138,198
    
    
    
    Principal payments on trading securities previously classified as available-for-sale
    
    
    187,338
    
    
    
    Origination and purchase of loans
    
    
    (15,646
    )
    
    
    (249,237
    )Principal payments on loans
    
    
    54,755
    
    
    
    152,267Proceeds from sale of loans
    
    
    33,701
    
    
    
    50,478Proceeds from sale of loans held for sale previously classified as held for investment
    
    
    11,387
    
    
    
    Purchase of other investments
    
    
    
    
    
    
    (550
    )Purchases of fixed assets
    
    
    (16
    )
    
    
    Net cash
provided by investing activities
    
    
    4,417,346
    
    
    
    1,279,313CASH FLOWS FROM FINANCING ACTIVITIES:Net payments under repurchase agreements
    
    
    (4,900,055
    )
    
    
    (550,184
    )Proceeds from issuance of long term debt
    
    
    
    
    
    
    231,000Payments made on long term debt
    
    
    
    
    
    
    (359
    )Proceeds from Wachovia Facility
    
    
    3,000
    
    
    
    78,200Payments made on Wachovia Facility
    
    
    (42,375
    )
    
    
    (262,215
    )Payment of debt issuance costs
    
    
    (875
    )
    
    
    (2,685
    )Payments on designated derivative containing a financing element
    
    
    
    
    
    
    (216
    )Dividends paid
    
    
    (21,690
    )
    
    
    (65,182
    )Payments made on short term debt
    
    
    (1,523
    )
    
    
    Net cash
used in financing activities
    
    
    (4,963,518
    )
    
    
    (571,641
    )Foreign currency translation
    
    
    (46
    )
    
    
    Net (decrease) increase in cash and cash equivalents
    
    
    (71,825
    )
    
    
    53,327Cash and cash equivalents at beginning of period
    
    
    113,733
    
    
    
    72,523Cash and cash equivalents at end of period
    
    $
    41,908
    
    
    $
    125,850
 10




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##### Table of Contents



DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (Continued)
 Nine months ended September 30,2008
    
    
    2007(In thousands)SUPPLEMENTAL DISCLOSURE:Cash paid for interest
    
    $
    108,246
    
    
    $
    227,311Cash paid for income taxes
    
    
    4,083
    
    
    
    NON CASH  INVESTING AND FINANCING ACTIVITIES:Unsettled trading purchases  due to broker
    
    
    
    
    
    
    269,752Unsettled available-for-sale-securities purchases  due to broker
    
    
    
    
    
    
    1,972Unsettled held for sale loan purchases  due to broker
    
    
    
    
    
    
    2,082Unsettled available-for-sale sales  due from broker
    
    
    
    
    
    
    93,547Net settlement of interest expense from derivatives
    
    
    
    
    
    
    5,880Settlement of interest income as an addition to principal balance of loans and loans held for sale
    
    
    4,894
    
    
    
    5,549Receipt of warrants
    
    
    1,092
    
    
    
    214Principal payments receivable from available-for-sale securities
    
    
    308
    
    
    
    17,144Principal payments receivable from bank loans held for investment
    
    
    
    
    
    
    225Issuance of stock for payment of prior year incentive fee
    
    
    
    
    
    
    3Share-based compensation
    
    
    2,789
    
    
    
    Dividends declared, not yet paid
    
    
    5,693
    
    
    
    Series A cumulative convertible preferred stock dividend and accretion
    
    
    2,393
    
    
    
    Merger purchase price adjustments
    
    
    561
    
    
    
    
  11




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##### Table of Contents



DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. ORGANIZATION
    Business Segments
  Investment Management
 Principal Investing
 Liquidity and Capital Resources
   12




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13




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##### Table of Contents



2. ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS
 Basis of Presentation
 Principles of Consolidation Consolidation of Variable
Interest Entities
 Reclassifications
 Significant Accounting Policies Fair Value Measurements The Fair Value Option for Financial Assets and Liabilities
 Fair Value Measurements and Presentation
 .
 Level 1
  Level 2
 14




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Level 3
        15




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##### Table of Contents



Impairment of Goodwill and Other Intangible Assets
 Goodwill and Other Intangible Assets
    Recent Accounting Pronouncements
 Accounting for Transfers of
Financial Assets and Repurchase Financing Transactions Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ,
 Disclosures about Derivative Instruments and
Hedging Activities Accounting for Derivative Instruments and Hedging Activities
 16




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Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities Earnings per Share
 Disclosures
about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB
Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161
 Determining the Fair Value of a Financial
Asset when the Market for that Asset is Not Active
 3. MERGER WITH DEERFIELD
  17




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##### Table of Contents



Original
    
    
    Purchase
    
    
    AdjustedEstimate of
    
    
    Price
    
    
    Estimate ofFair Value
    
    
    Adjustments
    
    
    Fair Value(In thousands)Fair value of assets acquired, excluding cash acquired
    
    $
    216,469
    
    
    $
    563
    
    
    $
    217,032Assumed liabilities
    
    
    (27,999
    )
    
    
    (2
    )
    
    
    (28,001
    )$
    188,470
    
    
    $
    561
    
    
    $
    189,031Summary of consideration, net of cash acquired:Series A Cumulative Convertible Preferred Stock, at
fair value
    
    
    116,015
    
    
    
    70
    
    
    
    116,085Series A and Series B Notes, at fair value
    
    
    71,206
    
    
    
    
    
    
    
    71,206Net cash acquired
    
    
    (13,609
    )
    
    
    
    
    
    
    (13,609
    )Other capitalized transaction costs
    
    
    14,858
    
    
    
    491
    
    
    
    15,349Total consideration
    
    $
    188,470
    
    
    $
    561
    
    
    $
    189,031
  Unaudited Pro Forma InformationThree months ended September 30, 2007
    
    Nine months ended September 30, 2007(In thousands, except per share data)Total net revenues
    
    $
    39,628
    
    
    $
    104,414(Loss) income before income tax expense
    
    $
    (30,927
    )
    
    $
    3,250Net income (loss)
    
    $
    (28,181
    )
    
    $
    6,820Net loss attributable to common
stockholders
    
    $
    (34,336
    )
    
    $
    (11,646
    )Net loss per share  basic and diluted
    
    $
    (6.60
    )
    
    $
    (2.30
    )
  4. FAIR VALUE OF FINANCIAL INSTRUMENTS
  18




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Available-for-sale securities
  Trading securities
    Derivative assets and liabilities
  Loans held for sale
  19




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##### Table of Contents



Assets and liabilities measured at fair value on a recurring basis
  Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Carrying Value(In thousands)Available-for-sale securities
    
    $
    
    
    
    $
    
    
    
    $
    5,078
    
    
    $
    5,078Trading securities
    
    
    
    
    
    
    394,335
    
    
    
    21,127
    
    
    
    415,462Derivative assets
    
    
    
    
    
    
    
    
    
    
    2,004
    
    
    
    2,004Total financial instrument assets
    
    $
    
    
    
    $
    394,335
    
    
    $
    28,209
    
    
    $
    422,544Derivative liabilities
    
    $
    
    
    
    $
    7,812
    
    
    $
    115
    
    
    $
    7,927
 Changes in Level 3 recurring fair value measurements
   Changes in UnrealizedFair Value Measurements Using Significant Unobservable Inputs
    
    
    Gains/(Losses)Estimated
    
    
    Net Realized/
    
    
    Purchases, (Sales),
    
    
    Net Transfers
    
    
    Estimated
    
    
    Related to FinancialFair Value
    
    
    Unrealized
    
    
    Issuances and
    
    
    In/Out
    
    
    Fair Value
    
    
    Instruments HeldJune 30, 2008
    
    
    Gains/(Losses)
    
    
    (Settlements), Net
    
    
    of Level 3
    
    
    September 30, 2008
    
    
    at September 30, 2008(In thousands)Available-for-sale securities
    
    $
    7,403
    
    
    $
    139
    (1)
    
    $
    (2,464
    )
    
    $
    
    
    
    $
    5,078
    
    
    $
    112
    (1)Trading securities
    
    
    30,512
    
    
    
    (8,725
    ) (2)
    
    
    (660
    )
    
    
    
    
    
    
    21,127
    
    
    
    (8,748
    ) (2)Derivative assets
    
    
    1,596
    
    
    
    500
    (3)
    
    
    (92
    )
    
    
    
    
    
    
    2,004
    
    
    
    408
    (3)Total financial
instrument assets
    
    $
    39,511
    
    
    $
    (8,086
    )
    
    $
    (3,216
    )
    
    $
    
    
    
    $
    28,209
    
    
    $
    (8,228
    )Derivative liabilities
    
    $
    646
    
    
    $
    1,052
    (3)
    
    $
    (1,583
    )
    
    $
    
    
    
    $
    115
    
    
    $
    (531)
    (3)
 
 (1)
    
    Net unrealized changes in fair value for available-for-sale securities are reported as an
adjustment to accumulated other comprehensive loss on the condensed consolidated statement of
stockholders equity. Impairment charges on available-for-sale securities are reported within
net loss on available-for-sale securities in the condensed consolidated statements of
operations.(2)
    
    Net realized and unrealized gains (losses) on trading securities are reported within net
(loss) gain on trading securities in the condensed consolidated statements of operations.(3)
    
    Net realized and unrealized gains (losses) on derivative assets and derivative liabilities
are recorded in net loss on derivatives in the condensed consolidated statements of
operations. 20




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##### Table of Contents



Changes in UnrealizedFair Value Measurements Using Significant Unobservable Inputs
    
    
    Gains/(Losses)Estimated
    
    
    Net Realized/
    
    
    Purchases, (Sales),
    
    
    Net Transfers
    
    
    Estimated
    
    
    Related to FinancialFair Value
    
    
    Unrealized
    
    
    Issuances and
    
    
    In/Out
    
    
    Fair Value
    
    
    Instruments HeldJanuary 1, 2008
    
    
    Gains/(Losses)
    
    
    (Settlements), Net
    
    
    of Level 3
    
    
    September 30, 2008
    
    
    at September 30, 2008(In thousands)Available-for-sale securities
    
    $
    10,268
    
    
    $
    (4,476
    ) (1)
    
    $
    (714
    )
    
    $
    
    
    
    $
    5,078
    
    
    $
    (4,529
    ) (1)Trading securities
    
    
    1,894,429
    
    
    
    (198,167
    ) (2)
    
    
    (1,645,399
    )
    
    
    (29,736
    ) (4)
    
    
    21,127
    
    
    
    (23,587
    ) (2)Derivative assets
    
    
    318
    
    
    
    (329
    ) (3)
    
    
    2,015
    
    
    
    
    
    
    
    2,004
    
    
    
    887
    (3)Total financial
instrument assets
    
    $
    1,905,015
    
    
    $
    (202,972
    )
    
    $
    (1,644,098
    )
    
    $
    (29,736
    )
    
    $
    28,209
    
    
    $
    (27,229
    )Derivative liabilities
    
    $
    1,493
    
    
    $
    (1,254
    ) (3)
    
    $
    (124
    )
    
    $
    
    
    
    $
    115
    
    
    $
    (2,348
    ) (3)
 
 (1)
    
    Net unrealized changes in fair value for available-for-sale securities are reported as an
adjustment to accumulated other comprehensive loss on the condensed consolidated statement of
stockholders equity. Impairment charges on available-for-sale securities are reported within
net loss on available-for-sale securities in the condensed consolidated statements of
operations.(2)
    
    Net realized and unrealized gains (losses) on trading securities are reported within net
(loss) gain on trading securities in the condensed consolidated statements of operations.(3)
    
    Net realized and unrealized gains (losses) on derivative assets and derivative liabilities
are recorded in net loss on derivatives in the condensed consolidated statements of
operations.(4)
    
    Net transfers out of Level 3 represent Agency RMBS priced by management by reference to
dealer quotes at January 1, 2008 and using modeled valuation with inputs observable in the
market as of September 30, 2008. Assets measured at fair value on a nonrecurring basis
  CarryingLevel 1
    
    
    Level 2
    
    
    Level 3
    
    
    Value(In thousands)Other investments
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    (1)Loans held for sale
    
    
    
    
    
    
    
    
    
    
    254,476
    
    
    
    254,476Loans held for investment
    
    
    
    
    
    
    
    
    
    
    6,372
    
    
    
    6,372Intangible assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2)Goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3)Total assets at fair value on a nonrecurring basis
    
    $
    
    
    
    $
    
    
    
    $
    260,848
    
    
    $
    260,848
 
 (1)
    
    An other-than-temporary impairment charge was recorded on a common equity security
accounted for under the cost method that was marked to a fair value of zero as of September
30, 2008. See Note 8 for further information.(2)
    
    Three intangible assets identified as a result of the Merger were impaired and marked
to a fair value of zero as of September 30, 2008. See Note 11 for further information.(3)
    
    Goodwill identified as a result of the Merger was impaired and marked to a fair value
of zero as of September 30, 2008. See Note 11 for further information. 21




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##### Table of Contents



Three months ended
    
    
    Nine months endedSeptember 30, 2008
    
    
    September 30, 2008(In thousands)Other investments
    
    $
    (708
    ) (1)
    
    $
    (708
    )Loans held for sale
    
    
    (43,600
    ) (2)
    
    
    (73,148
    )Loans held for investment
    
    
    (13,713
    ) (3)
    
    
    (14,096
    )Intangible assets
    
    
    (32,110
    ) (4)
    
    
    (32,110
    )Goodwill
    
    
    (78,158
    ) (4)
    
    
    (98,126
    )Total nonrecurring fair value gains (losses)
    
    $
    (168,289
    )
    
    $
    (218,188
    )
 
 (1)
    
    Impairment charges to mark other investments at fair value are reported within dividend
income and other net loss in the condensed consolidated statements of operations.(2)
    
    Changes in the fair value on loans held for sale are reported within net loss on loans and
loans held for sale in the condensed consolidated statements of operations.(3)
    
    Impairment charges to mark loans held for investment at fair value are reported within
provision for loan losses in the condensed consolidated statements of operations.(4)
    
    Impairment charges on intangible assets and goodwill are reported within impairment of
intangible assets and goodwill in the condensed consolidated statements of operations. 5. FAIR VALUE OPTION
  22




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6. AVAILABLE-FOR-SALE SECURITIES
  Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedSecurity Description
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair Value(In thousands)High-yield corporate bonds
held in Market Square CLO
    
    $
    3,981
    
    
    $
    
    
    
    $
    (1,101
    )
    
    $
    2,880ABS held in Market Square CLO
    
    
    2,379
    
    
    
    
    
    
    
    (222
    )
    
    
    2,157CMBS
    
    
    41
    
    
    
    
    
    
    
    
    
    
    
    41Total
    
    $
    6,401
    
    
    $
    
    
    
    $
    (1,323
    )
    
    $
    5,078
  23




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##### Table of Contents



WeightedAmortized
    
    
    Estimated
    
    
    AverageWeighted Average Life
    
    Cost
    
    
    Fair Value
    
    
    Coupon(In thousands)Greater than five years and less
than ten years
    
    $
    5,773
    
    
    $
    4,536
    
    
    
    7.43
    %Greater than ten years
    
    
    628
    
    
    
    542
    
    
    
    12.32
    %Total
    
    $
    6,401
    
    
    $
    5,078
    
    
    
    7.69
    %
  Less than 12 MonthsNumber
    
    
    Estimated
    
    
    Grossof
    
    
    Fair
    
    
    UnrealizedSecurities
    
    
    Value
    
    
    Losses(In thousands)High-yield corporate bonds held in Market Square CLO
    
    
    2
    
    
    $
    2,880
    
    
    $
    (1,101
    )ABS held in Market Square CLO
    
    
    6
    
    
    
    2,157
    
    
    
    (222
    )Total temporarily impaired securities
    
    
    8
    
    
    $
    5,037
    
    
    $
    (1,323
    )
   
    
    severity of the impairment;
    
    the length of time and the extent to which the market value has been less than the
amortized cost;
    
    whether the security has been downgraded by a rating agency;
    
    the financial condition of the investee and the prospect for future recovery; and
    
    the Companys intent and ability to hold the security for a period of time
sufficient to allow for any anticipated recovery in market value.
 24




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##### Table of Contents



Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets
   Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands)Realized gains
    
    $
    23
    
    
    $
    4,274
    
    
    $
    23
    
    
    $
    8,953Realized losses
    
    
    
    
    
    
    (11,085
    )
    
    
    
    
    
    
    (13,256
    )Net realized gains (losses)
    
    
    23
    
    
    
    (6,811
    )
    
    
    23
    
    
    
    (4,303
    )Other-than-temporary
impairment
    
    
    (879
    )
    
    
    (16,365
    )
    
    
    (4,735
    )
    
    
    (16,567
    )Net loss
    
    $
    (856
    )
    
    $
    (23,176
    )
    
    $
    (4,712
    )
    
    $
    (20,870
    )
  7. TRADING SECURITIES
  EstimatedSecurity
Description
    
    Fair Value(In thousands)RMBS:Agency RMBS
    
    $
    394,335Non-Agency RMBS
    
    
    20,167Preferred shares of CDOs
    
    
    960Total
    
    $
    415,462
 25




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##### Table of Contents



WeightedAmortized
    
    
    Estimated
    
    
    AverageWeighted
Average Life
    
    Cost
    
    
    Fair Value
    
    
    Coupon(In thousands)Greater than one year and less
than five years
    
    $
    170,853
    
    
    $
    164,039
    
    
    
    5.08
    %Greater than five years and less
than ten years
    
    
    269,072
    
    
    
    251,423
    
    
    
    5.24
    %Total
    
    $
    439,925
    
    
    $
    415,462
    
    
    
    5.18
    %
    Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands)Realized gains
    
    $
    85
    
    
    $
    
    
    
    $
    44,409
    
    
    $
    398Realized losses
    
    
    
    
    
    
    (2,458
    )
    
    
    (213,466
    )
    
    
    (2,524
    )Net realized gains
(losses)
    
    $
    85
    
    
    $
    (2,458
    )
    
    $
    (169,057
    )
    
    $
    (2,126
    )
 26




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##### Table of Contents



8. OTHER INVESTMENTS
 Cost Method Investments
  Equity Method Investments
  9. LOANS AND LOANS HELD FOR SALE
  Carrying ValueLoans HeldType of Loan
    
    for Sale (1)
    
    
    Loans
    
    
    Total(In thousands)Loans held in Market Square CLO
    
    $
    245,045
    
    
    $
    
    
    
    $
    245,045Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    
    
    
    
    256,818
    
    
    
    256,818Loans held in Wachovia Facility
    
    
    22,374
    
    
    
    55,302
    
    
    
    77,676Other corporate leveraged loans
    
    
    
    
    
    
    32,259
    
    
    
    32,259Commercial real estate loans
    
    
    
    
    
    
    12,330
    
    
    
    12,330$
    267,419
    
    
    
    356,709
    
    
    
    624,128Allowance for loan losses
    
    
    
    
    
    
    (21,596
    )
    
    
    (21,596
    )$
    335,113
    
    
    $
    602,532
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value. 27




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##### Table of Contents



Number
    
    
    Notional
    
    
    AllowanceType of Loan
    
    of Loans
    
    
    Amount
    
    
    for Loan Losses(In thousands)Corporate leveraged loans:Loans held in DFR MM CLO (1)
    
    
    1
    
    
    $
    9,000
    
    
    $
    6,750Loans held in Wachovia Facility (1)
    
    
    1
    
    
    
    6,000
    
    
    
    4,500Other corporate leveraged loans
    
    
    1
    
    
    
    10,000
    
    
    
    7,500Commercial real estate loans
    
    
    2
    
    
    
    5,117
    
    
    
    2,846Total
    
    
    5
    
    
    $
    30,117
    
    
    $
    21,596
 
 (1)
    
    Represents one loan with an allowance for loan losses held in both the DFR MM CLO and the
Wachovia Facility.     28




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##### Table of Contents



Allowance for Loan Losses2008
    
    
    2007(In thousands)Allowance for loan losses at January 1
    
    $
    5,300
    
    
    $
    2,000Provision for loan losses
    
    
    2,200
    
    
    
    1,800Allowance for loan losses at March 31
    
    
    7,500
    
    
    
    3,800Provision for loan losses
    
    
    2,302
    
    
    
    5,133Charge-offs
    
    
    (600
    )
    
    
    Transfers to loans held for sale
    
    
    (1,319
    )
    
    
    Allowance for loan losses at June 30
    
    
    7,883
    
    
    
    8,933Provision for loan losses
    
    
    15,459
    
    
    
    Charge-offs
    
    
    (25
    )
    
    
    Transfers to loans held for sale
    
    
    (1,721
    )
    
    
    Allowance for loan losses at September 30
    
    $
    21,596
    
    
    $
    8,933
  10. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
   Notional
    
    
    
    
    
    
    
    
    
    
    Estimated NetCount
    
    
    Amount
    
    
    Assets
    
    
    Liabilities
    
    
    Fair Value(In thousands)Interest rate swaps
    
    
    8
    
    
    $
    263,000
    
    
    $
    
    
    
    $
    (7,697
    )
    
    $
    (7,697
    )Interest rate cap
    
    
    1
    
    
    
    40,000
    
    
    
    
    
    
    
    (115
    )
    
    
    (115
    )Credit default
swaps  protection
seller
    
    
    1
    
    
    
    5,000
    
    
    
    
    
    
    
    (115
    )
    
    
    (115
    )Total return swaps
    
    
    1
    
    
    
    5,742
    
    
    
    499
    
    
    
    
    
    
    
    499Warrants
    
    
    3
    
    
    
    n/a
    
    
    
    1,505
    
    
    
    
    
    
    
    1,50514
    
    
    $
    313,742
    
    
    $
    2,004
    
    
    $
    (7,927
    )
    
    $
    (5,923
    )
 
 n/a  not applicable 29




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Interest Rate Swaps
  , Accounting for Derivatives and
Hedging Activities,
  30




---



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Interest Rate Cap
  Credit Default Swaps
  Total Return Swaps
  Warrants
  31




---



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11. IMPAIRMENT OF INTANGIBLE ASSETS AND GOODWILL
    12. REPURCHASE AGREEMENTS
  32




---



##### Table of Contents



Between1 Day or
    
    2 and 30Less
    
    Days
    
    Total(In thousands)Estimated fair value of securities pledged,
including accrued interest (1)
    
    $
    65,242
    
    
    $
    343,418
    
    
    $
    408,660Repurchase agreement liabilities associated
with these securities
    
    
    51,861
    
    
    
    331,756
    
    
    
    383,617Weighted average interest rate of
repurchase agreement liabilities
    
    
    4.59
    %
    
    
    3.28
    %
    
    
    3.46
    %
 
 (1)
    
    Represents the current fair value of securities delivered as collateral at the inception of
the repurchase agreement, including accrued interest.  Accrued Interest
    
    Accrued InterestIncluded in Estimated
    
    Included inFair Value of
    
    Repurchase AgreementType of Investment Pledged
    
    Securities Pledged
    
    Liabilities(In thousands)RMBS
    
    $
    1,802

    
    $
    336
  Weighted-AverageMaturity of RepurchaseAmount at Risk (1)
    
    
    AgreementsCounterparties:
    
    (In thousands)
    
    
    (In days)Bank of America Securities LLC
    
    $
    9,219
    
    
    
    1Deutsche Bank Securities Inc.
    
    
    6,655
    
    
    
    1Fortis Securities LLC
    
    
    8,455
    
    
    
    14HSBC Securities (USA), Inc.
    
    
    1,778
    
    
    
    3Total
    
    $
    26,107
    
    
    
    11
 
 (1)
    
    Equal to the fair value of securities pledged (including net additional repurchase agreement
collateral pledged of $1.1 million), minus repurchase agreement liabilities and related
accrued interest payable. 33




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##### Table of Contents



13. SECURITIES RECEIVED AND PLEDGED AS COLLATERAL
   14. SHORT TERM DEBT
  15. LONG TERM DEBT
  Weighted
    
    
    Estimated Fair ValueCarrying
    
    
    Average
    
    
    of CollateralValue
    
    
    Rate
    
    
    (including accrued interest)(In thousands)
    
    
    
    
    
    
    (In thousands)Wachovia Facility
    
    $
    34,060
    
    
    
    5.10
    %
    
    $
    76,740Market Square CLO
    
    
    276,000
    
    
    
    3.28
    %
    
    
    258,858DFR MM CLO
    
    
    231,000
    
    
    
    3.48
    %
    
    
    303,750Trust preferred securities
    
    
    123,717
    
    
    
    5.57
    %
    
    
    n/aSeries A and Series B Notes
    
    
    71,631
    
    
    
    7.79
    %
    
    
    71,588
    (1)Total long term debt
    
    $
    736,408
    
    
    
    4.25
    %
    
    $
    710,936
 
 (1)
    
    Includes the assets of Deerfield, as issuer of the Series A and Series B Notes, but does not
include the assets of any guarantors thereof.n/a
    
     not applicable 34




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Trust Preferred Securities
     Series A and Series B Notes
  35




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Wachovia Facility
    36




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16. STOCKHOLDERS EQUITY
    Performance shares as of December 31, 2007
    
    
    Granted
    
    
    231,468Forfeited
    
    
    (22,814
    )Performance shares as of September 30, 2008
    
    
    208,654
   Non-vested as of December 31, 2007
    
    
    9,740Granted
    
    
    Vested
    
    
    (3,247
    )Forfeited
    
    
    (130
    )Non-vested as of September 30, 2008
    
    
    6,363
   37




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##### Table of Contents



17. COMPUTATION OF EARNINGS PER SHARE
  Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands, except per share data)Net (loss) income
    
    $
    (156,883
    )
    
    $
    (23,235
    )
    
    $
    (614,801
    )
    
    $
    13,786Weighted average shares used in basic computation:Common Stock
    
    
    6,878
    
    
    
    5,162
    
    
    
    6,437
    
    
    
    5,160Dilutive effect of:Unvested restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11Weighted average shares used in diluted computation
    
    
    6,878
    
    
    
    5,162
    
    
    
    6,437
    
    
    
    5,171Net (loss) income per share  basic
    
    $
    (22.81
    )
    
    $
    (4.50
    )
    
    $
    (95.52
    )
    
    $
    2.67Net (loss) income per share  diluted
    
    $
    (22.81
    )
    
    $
    (4.50
    )
    
    $
    (95.52
    )
    
    $
    2.67The 14,999,992 shares of Series A Preferred Stock (not adjusted to reflect the 1-for-10
reverse stock split effected on October 16, 2008) are not included in calculation of diluted net
loss per share for the nine months ended September 30, 2008 because their effect was anti-dilutive.
Potentially dilutive shares relating to the option to purchase 134,615 shares of common stock are
not included in the calculation of diluted net income per share for the three and nine months ended
September 30, 2007 because the effect was anti-dilutive. Additionally, 11,460 shares of unvested
restricted stock are not included in the calculation of diluted net income per share for the three
months ended September 30, 2007 because the effect was anti-dilutive as a result of the reporting
of a net loss for the period.18. ACCUMULATED OTHER COMPREHENSIVE LOSSThe following is a summary of the components of accumulated other comprehensive loss:For the nine months ended September 30, 2008Available-for-
    
    
    Cash Flow
    
    
    Foreign CurrencySale Securities
    
    
    Hedges
    
    
    Translation
    
    
    Total(In thousands)Beginning balance  December 31, 2007
    
    $
    13,413
    
    
    $
    (97,239
    )
    
    $
    43
    
    
    $
    (83,783
    )Cumulative effect adjustment from the
adoption of SFAS No. 159
    
    
    (14,914
    )
    
    
    
    
    
    
    
    
    
    
    (14,914
    )Unrealized net gain for the period
    
    
    178
    
    
    
    
    
    
    
    
    
    
    
    178Foreign currency loss
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    (2
    )Reclassification adjustments:Accelerated amortization (1)
    
    
    
    
    
    
    91,651
    
    
    
    
    
    
    
    91,651Hedging amortization recognized in
earnings
    
    
    
    
    
    
    5,345
    
    
    
    
    
    
    
    5,345Ending balance  September 30, 2008
    
    $
    (1,323
    )
    
    $
    (243
    )
    
    $
    41
    
    
    $
    (1,525
    )
 
 (1)
    
    Due to the repayments of repurchase agreement obligations during the nine months ended
September 30, 2008, $91.7 million was reclassified from other comprehensive loss to net gain
(loss) on derivatives related to the change in forecasted repurchase agreement transactions. 38




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19. INCOME TAXES
    Accounting for Income Taxes "
  39




---



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40




---



##### Table of Contents



Deferred tax assets:Provision for loan loss
    
    $
    10,066RMBS book/tax differences
    
    
    16,601Unrealized gains/losses-bank loans
    
    
    15,727Impairment charges on intangible assets and goodwill
    
    
    52,223Net loss on terminated tax hedges
    
    
    60,249Other unrealized net losses
    
    
    6,133Accrued expenses
    
    
    3,783Excess capital losses
    
    
    139,257Net operating loss carryforward
    
    
    18,124Other
    
    
    3,212Gross deferred tax asset
    
    
    325,375Less: Valuation allowance
    
    
    (322,989
    )Deferred tax asset
    
    
    2,386Deferred tax liability
    
    
    (2,386
    )Net deferred tax asset
    
    $
    
   41




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##### Table of Contents



Three months ended
    
    
    Nine months endedSeptember 30, 2008
    
    
    September 30, 2008Tax
    
    
    Rate
    
    
    Tax
    
    
    Rate(In thousands)
    
    
    
    
    
    
    (In thousands)Pretax book income at statutory tax rate
    
    $
    (60,636
    )
    
    
    39.85
    %
    
    $
    (244,839
    )
    
    
    39.85
    %Non-U.S. income taxed at different rates
    
    
    12
    
    
    
    -0.01
    %
    
    
    50
    
    
    
    -0.01
    %Permanent Differences:Nondeductible expenses
    
    
    21
    
    
    
    -0.01
    %
    
    
    22
    
    
    
    0.00
    %Nondeductible goodwill
    
    
    
    
    
    
    0.00
    %
    
    
    3,288
    
    
    
    -0.54
    %Tax effect of REIT termination
effective January 1, 2008
    
    
    (257,694
    )
    
    
    169.35
    %
    
    
    (81,550
    )
    
    
    13.27
    %Valuation allowance
    
    
    322,606
    
    
    
    -212.01
    %
    
    
    322,989
    
    
    
    -52.56
    %Other
    
    
    409
    
    
    
    -27.00
    %
    
    
    424
    
    
    
    -0.07
    %Total income tax expense
    
    $
    4,718
    
    
    
    -3.10
    %
    
    $
    384
    
    
    
    -0.06
    %
 20. SEGMENT REPORTING
  For three months ended September 30, 2008(In thousands)Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    ConsolidatedInterest income
    
    $
    127
    
    
    $
    20,379
    
    
    $
    
    
    
    $
    20,506Interest expense
    
    
    1,719
    
    
    
    9,952
    
    
    
    
    
    
    
    11,671Net interest (expense) income
    
    
    (1,592
    )
    
    
    10,427
    
    
    
    
    
    
    
    8,835Provision for loan losses
    
    
    
    
    
    
    15,459
    
    
    
    
    
    
    
    15,459Net interest (expense)
income after provision for
loan losses
    
    
    (1,592
    )
    
    
    (5,032
    )
    
    
    
    
    
    
    (6,624
    )Investment advisory fees
    
    
    11,158
    
    
    
    
    
    
    
    (2,143
    )
    
    
    9,015Total net revenues
    
    $
    9,566
    
    
    $
    (5,032
    )
    
    $
    (2,143
    ) (1)
    
    $
    2,391Depreciation and amortization
    
    $
    2,498
    
    
    $
    
    
    
    $
    
    
    
    $
    2,498Income tax expense (benefit)
    
    $
    8,302
    
    
    $
    (3,584
    )
    
    $
    
    
    
    $
    4,718Net loss
    
    $
    (119,183
    )
    
    $
    (37,700
    )
    
    $
    
    
    
    $
    (156,883
    )
 42




---



##### Table of Contents



For nine months ended September 30, 2008(In thousands)Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    ConsolidatedInterest income
    
    $
    624
    
    
    $
    103,056
    
    
    $
    
    
    
    $
    103,680Interest expense
    
    
    5,273
    
    
    
    66,419
    
    
    
    
    
    
    
    71,692Net interest (expense) income
    
    
    (4,649
    )
    
    
    36,637
    
    
    
    
    
    
    
    31,988Provision for loan losses
    
    
    
    
    
    
    19,961
    
    
    
    
    
    
    
    19,961Net interest (expense)
income after provision for
loan losses
    
    
    (4,649
    )
    
    
    16,676
    
    
    
    
    
    
    
    12,027Investment advisory fees
    
    
    44,018
    
    
    
    
    
    
    
    (10,525
    )
    
    
    33,493Total net revenues
    
    $
    39,369
    
    
    $
    16,676
    
    
    $
    (10,525
    ) (1)
    
    $
    45,520Depreciation and amortization
    
    $
    7,765
    
    
    $
    
    
    
    $
    
    
    
    $
    7,765Income tax expense
    
    $
    111
    
    
    $
    273
    
    
    $
    
    
    
    $
    384Net loss
    
    $
    (139,229
    )
    
    $
    (475,572
    )
    
    $
    
    
    
    $
    (614,801
    )
 As of September 30, 2008(In thousands)Identifiable assets
    
    $
    71,588
    
    
    $
    1,150,131
    
    
    $
    (465)
    (2)
    
    $
    1,221,254
 
 (1)
    
    Represents the fees charged to the Principal Investing segment by the Investment Management
segment on a cost plus basis for investment advisory, management and operational services.(2)
    
    Represents the payable for fees charged to the Principal Investing segment by the Investment
Management segment and the intercompany receivable from the Principal Investing segment for
expenses paid by the Investment Management segment which have not yet been reimbursed by the
Principal Investing segment. 21. COMMITMENTS AND CONTINGENCIES
 Legal Proceedings
   NYSE Listing
   43




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Rothschild Compensation Agreement
  Other Commitments
  22. SUBSEQUENT EVENTS
 Trust Preferred Securities
  Cost Savings Initiative
   44




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Part II  Item 1A. Risk Factors Part I  Item 1A. Risk Factors. Part I  Item 1. Financial Statements
 General
  Overview
 Significant RMBS Portfolio Activity
  45




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##### Table of Contents



Recent Developments
    Significant RMBS Portfolio Activity
    46




---



##### Table of Contents




    
    Agency RMBS with an amortized cost of $4.6 billion were sold at a net realized gain of
$24.4 million.
    
    Non-Agency RMBS with an amortized cost of $1.6 billion were sold at a net realized loss
of $193.5 million.
    
    The net notional amount of interest rate swaps used to hedge the RMBS portfolio was
reduced by $6.2 billion. Net losses in this portfolio for the three months ended March 31,
2008 totaled $219.3 million.
 Our Business
  Part II  Item 1A. Risk Factors
 Investment Management Segment
   47




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##### Table of Contents



AUM
  Number of
    
    
    AUM as ofAccounts
    
    
    October 1, 2008 (1)(In thousands)CDOs (2)CLOs (3)
    
    
    14
    
    
    $
    4,738,850Asset-backed securities
    
    
    12
    
    
    
    5,780,808Corporate bonds
    
    
    3
    
    
    
    797,139Total CDOs
    
    
    29
    
    
    
    11,316,797Investment Fund (4)Fixed income arbitrage
    
    
    1
    
    
    
    330,959Separately managed accounts (5)
    
    
    6
    
    
    
    267,295Total AUM (6)
    
    
    
    
    
    $
    11,915,051
 
 (1)
    
    AUM numbers are reported as of October 1, 2008, rather than as of September 30, 2008.(2)
    
    CDO AUM numbers generally reflect the aggregate principal or notional balance of the
collateral and, in some cases, the cash balance held by the CDOs and are as of the date of the
last trustee report received for each CDO prior to October 1, 2008. Our CDOs/CLOs AUM
includes AUM related to our structured loan fund.(3)
    
    The AUM for our Euro-denominated CLO has been converted into U.S. dollars using the spot rate
of exchange on September 30, 2008.(4)
    
    The number of accounts for the Investment Fund does not include feeder funds, which are funds
that invest all or substantially all of their assets into a trading fund which we manage,
although some of our management fees are paid pursuant to contracts with those feeder funds.
This Investment Fund is expected to be liquidated no later than November 30, 2008.(5)
    
    AUM for certain of the separately managed accounts is a multiple of the capital actually
invested in such account. Management fees for these accounts are paid on this levered AUM
number.(6)
    
    Included in Total AUM are $294.1 million and $300.9 million related to Market Square CLO
Ltd., or Market Square CLO, and DFR Middle Market CLO Ltd., or DFR MM CLO, respectively, which
amounts are also included in the total reported for the Principal Investing segment. DCM
manages these CDOs but is not contractually entitled to receive any management fees for so
long as 100% of the equity is held by Deerfield Capital LLC, or DC LLC, or an affiliate
thereof. All other amounts included in the Principal Investing portfolio are excluded from
Total AUM. Principal Investing Segment
  48




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##### Table of Contents



September 30, 2008Carrying
    
    
    % of TotalPrincipal Investments
    
    Value
    
    
    Investments(In thousands)RMBS

    
    $
    414,502
    
    
    
    39.5
    %Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    256,818
    
    
    
    24.5
    %Loans held in Wachovia Facility
    
    
    77,676
    
    
    
    7.4
    %Other corporate leveraged loans (1)
    
    
    32,259
    
    
    
    3.1
    %Assets held in Market Square CLO (2)
    
    
    250,082
    
    
    
    23.8
    %Commercial real estate loans and securities
    
    
    12,371
    
    
    
    1.2
    %Equity securities
    
    
    4,764
    
    
    
    0.5
    %Total Investments
    
    
    1,048,472
    
    
    
    100.0
    %Allowance for loan losses
    
    
    (21,596
    )Net Investments
    
    $
    1,026,876
 
 (1)
    
    Other corporate leveraged loans excludes credit default swaps and total return swaps.(2)
    
    Includes syndicated bank loans of $245.0 million, high yield corporate bonds of $2.9 million
and ABS of $2.2 million as of September 30, 2008. Trends
  Credit market dislocation.
 Liquidity.
 49




---



##### Table of Contents



Corporate credit performance.
 Credit spreads.
 CDO financing and management. CDOs
   50




---



##### Table of Contents



Interest rate environment.
 Shape of the yield curve
 Prepayment rates.
 Valuation of investments.
 Reliance on agency ratings.
 51




---



##### Table of Contents



Critical Accounting Policies
  Fair Value of Financial Instruments
 Fair Value Measurements, .
 Level 1
  Level 2
  Level 3
   52




---



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53




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##### Table of Contents



Available-for-sale securities
    
    
    severity of impairment;
    
    the length of time and the extent to which the market value has been less than the
amortized cost;
    
    whether the security has been downgraded by a rating agency;
    
    the financial condition of the investee and the prospect for future recovery; and
    
    our intent and ability to hold the security for a period of time sufficient to
allow for any anticipated recovery in market value.
 Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securities Financial Assets,
 Trading securities
  54




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##### Table of Contents



Derivative assets and liabilities
  Loans Held for Sale
  Fair Value Option
 The Fair Value Option for Financial Assets
and Liabilities,
 55




---



##### Table of Contents



Interest Income Recognition
 Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases.
  Investment Advisory Fees
 Accounting for Management Fees Based on a Formula
  56




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##### Table of Contents



Loans
  Allowance and Provision for Loan Losses
 Accounting by Creditors for Impairment of a Loan
   Impairment of Goodwill and Other Intangible Assets
 Goodwill and Other Intangible Assets
   57




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Variable Interest Entities
 Consolidation of Variable Interest Entities
 Income Taxes
    Accounting for
Income Taxes,
 58




---



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59




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##### Table of Contents



Derivatives and Hedging,
 Recent Accounting Pronouncements
 Accounting for Transfers of
Financial Assets and Repurchase Financing Transactions Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
 Disclosures about Derivative Instruments and
Hedging Activities. Accounting for Derivative Instruments and Hedging Activities
 60




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Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating Securities, Earnings per Share
 Disclosures
about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB
Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161,
 Determining the Fair Value of a Financial
Asset when the Market for that Asset is Not Active
 61




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Financial Condition
  Carrying ValueAvailable-for-
    
    
    Trading
    
    
    Other
    
    
    Loans HeldSecurity Description
    
    Sale Securities
    
    
    Securities
    
    
    Investments
    
    
    For Sale
    
    
    Loans
    
    
    Total(In thousands)RMBS
    
    $
    
    
    
    $
    414,502
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    414,502Corporate leveraged loans (1):Loans held in DFR MM CLO (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    256,818
    
    
    
    256,818Loans held in Wachovia Facility (3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,374
    
    
    
    55,302
    
    
    
    77,676Other corporate leveraged loans (4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,259
    
    
    
    32,259Commercial mortgage-backed assets (5)
    
    
    41
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,330
    
    
    
    12,371Equity securities
    
    
    
    
    
    
    
    
    
    
    4,764
    
    
    
    
    
    
    
    
    
    
    
    4,764Total structured and syndicated assets
    
    
    41
    
    
    
    
    
    
    
    4,764
    
    
    
    22,374
    
    
    
    356,709
    
    
    
    383,888Assets held in Market Square CLO (6)
    
    
    5,037
    
    
    
    
    
    
    
    
    
    
    
    245,045
    
    
    
    
    
    
    
    250,082Other investments and loans (7)
    
    
    
    
    
    
    960
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    960Total alternative assets
    
    
    5,078
    
    
    
    960
    
    
    
    4,764
    
    
    
    267,419
    
    
    
    356,709
    
    
    
    634,930Total invested assets
    
    $
    5,078
    
    
    $
    415,462
    
    
    $
    4,764
    
    
    $
    267,419
    
    
    
    356,709
    
    
    $
    1,049,432Allowance for loan losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,596
    )$
    335,113
 
 (1)
    
    Corporate leveraged loans exclude a CDS with a negative fair value of $0.1 million and a $5.0
million notional value. Also excluded is a total return swap with a positive fair value of
$0.5 million and a $5.7 million notional value.(2)
    
    Amount is reported gross of the $6.8 million allowance for loan losses.(3)
    
    Loans held in Wachovia Facility classified as loans are reported gross of the $4.5 million
allowance for loan losses.(4)
    
    Amount is reported gross of the $7.5 million allowance for loan losses.(5)
    
    Commercial mortgage-backed assets classified as Loans are reported gross of the $2.8 million
allowance for loan losses.(6)
    
    Includes syndicated bank loans of $245.0 million, high yield corporate bonds of $2.9 million
and ABS of $2.2 million as of September 30, 2008.(7)
    
    Other investments and loans includes $1.0 million of preferred shares of CDOs owned by DCM
and considered assets of our Investment Management segment. Residential Mortgage-Backed Securities
  September 30, 2008Agency
    
    
    Non-AgencyRMBS
    
    
    RMBS
    
    
    Total(In thousands)Trading RMBS securities  fair value
    
    $
    394,335
    
    
    $
    20,167
    
    
    $
    414,502
 62




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63




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Weighted AverageContractual
    
    
    ConstantPar
    
    
    Estimated
    
    
    
    
    
    
    Months to
    
    
    Yield to
    
    
    Maturity
    
    
    Prepayment
    
    
    ModifiedSecurity Description
    
    Amount
    
    
    Fair Value
    
    
    Coupon
    
    
    Reset (1)
    
    
    Maturity
    
    
    (Month/Year)
    
    
    Rate (2)
    
    
    Duration (3)(In thousands)Hybrid Adjustable Rate RMBS:Rate reset in 1 year or less
    
    $
    56,281
    
    
    $
    55,541
    
    
    
    5.39
    %
    
    
    6
    
    
    
    5.12
    %
    
    
    5/24/2036
    
    
    
    15.5
    
    
    
    1.3Rate reset in 1 to 3 years
    
    
    256,468
    
    
    
    255,113
    
    
    
    4.84
    %
    
    
    21
    
    
    
    5.16
    %
    
    
    2/21/2035
    
    
    
    15.6
    
    
    
    1.7Rate reset in 3 to 5 years
    
    
    30,917
    
    
    
    31,225
    
    
    
    5.68
    %
    
    
    40
    
    
    
    5.26
    %
    
    
    9/7/2036
    
    
    
    14.1
    
    
    
    2.5Rate reset in 5 to 7 years
    
    
    10,084
    
    
    
    9,971
    
    
    
    4.94
    %
    
    
    82
    
    
    
    4.79
    %
    
    
    9/1/2035
    
    
    
    7.9
    
    
    
    3.5Rate reset in 7 to 10 years
    
    
    27,373
    
    
    
    16,493
    
    
    
    5.85
    %
    
    
    89
    
    
    
    16.97
    %
    
    
    3/30/2036
    
    
    
    10.6
    
    
    
    10.1Fixed Rate RMBS:30 year
    
    
    56,548
    
    
    
    46,159
    
    
    
    6.11
    %
    
    
    n/a
    
    
    
    11.33
    %
    
    
    5/9/2035
    
    
    
    14.4
    
    
    
    6.8Total hybrid and fixed rate RMBS
    
    $
    437,671
    
    
    $
    414,502
 
 (1)
    
    Represents number of months before conversion to floating rate.(2)
    
    Constant prepayment rate refers to the expected average annualized percentage rate of
principal prepayments over the remaining life of the security. The values represented in this
table are estimates only and the results of a third party financial model.(3)
    
    Modified duration represents the approximate percentage change in market value per 100 basis
point change in interest rates.      64




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September 30, 2008Amortized
    
    
    FairExpected Life
    
    Cost
    
    
    Value(In thousands)Greater than one year and less than five years
    
    $
    170,853
    
    
    $
    164,039Greater than five years and less than ten years
    
    
    266,140
    
    
    
    250,463Total
    
    $
    436,993
    
    
    $
    414,502
   Loans Held for Sale and Loans Held for Investment
  Carrying ValueLoans HeldType
of Loan
    
    for Sale (1)
    
    
    Loans
    
    
    Total(In thousands)Loans held in Market Square CLO
    
    $
    245,045
    
    
    $
    
    
    
    $
    245,045Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    
    
    
    
    256,818
    
    
    
    256,818Loans held in Wachovia Facility
    
    
    22,374
    
    
    
    55,302
    
    
    
    77,676Other corporate leveraged loans
    
    
    
    
    
    
    32,259
    
    
    
    32,259Commercial real estate loans
    
    
    
    
    
    
    12,330
    
    
    
    12,330$
    267,419
    
    
    
    356,709
    
    
    
    624,128Allowance for loan losses
    
    
    
    
    
    
    (21,596
    )
    
    
    (21,596
    )$
    335,113
    
    
    $
    602,532
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value. 65




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Number
    
    
    
    
    
    
    AllowanceType of Loan
    
    of Loans
    
    
    Notional
    
    
    for Loan Losses(In thousands)Corporate leveraged loans:Loans held in DFR MM CLO (1)
    
    
    1
    
    
    $
    9,000
    
    
    $
    6,750Loans held in Wachovia Facility (1)
    
    
    1
    
    
    
    6,000
    
    
    
    4,500Other corporate leveraged loans
    
    
    1
    
    
    
    10,000
    
    
    
    7,500Commercial real estate loans
    
    
    2
    
    
    
    5,117
    
    
    
    2,846Total
    
    
    5
    
    
    $
    30,117
    
    
    $
    21,596
 
 (1)
    
    Represents one loan with an allowance for loan losses held in both the DFR MM CLO and the
Wachovia Facility.  Loans Held in Market Square CLO
   66




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Estimated
    
    
    Weighted AverageMoodys
    
    Par
    
    
    Carrying
    
    
    Fair
    
    
    
    
    
    
    ContractualRating
    
    Value
    
    
    Value
    
    
    Value
    
    
    Coupon
    
    
    Maturity(In thousands)
    
    
    
    
    
    
    (Month/Year)Baa3
    
    $
    3,837
    
    
    $
    3,660
    
    
    $
    3,660
    
    
    
    6.01
    %
    
    
    05/13Ba1
    
    
    18,137
    
    
    
    16,802
    
    
    
    16,802
    
    
    
    4.75
    %
    
    
    08/12Ba2
    
    
    18,679
    
    
    
    17,289
    
    
    
    17,291
    
    
    
    5.07
    %
    
    
    10/13Ba3
    
    
    41,095
    
    
    
    34,977
    
    
    
    35,054
    
    
    
    5.46
    %
    
    
    04/13B1
    
    
    75,588
    
    
    
    66,263
    
    
    
    66,378
    
    
    
    5.86
    %
    
    
    09/13B2
    
    
    84,353
    
    
    
    71,777
    
    
    
    71,883
    
    
    
    6.08
    %
    
    
    05/13B3
    
    
    30,988
    
    
    
    24,383
    
    
    
    24,383
    
    
    
    6.23
    %
    
    
    07/13Caa1
    
    
    6,504
    
    
    
    5,098
    
    
    
    5,098
    
    
    
    6.61
    %
    
    
    12/12Caa2
    
    
    4,925
    
    
    
    3,264
    
    
    
    3,264
    
    
    
    6.77
    %
    
    
    8/13Caa3
    
    
    977
    
    
    
    698
    
    
    
    699
    
    
    
    5.57
    %
    
    
    7/11Ca
    
    
    2,327
    
    
    
    833
    
    
    
    833
    
    
    
    13.67
    %
    
    
    08/12$
    287,410
    
    
    $
    245,044
    
    
    $
    245,345
    
    
    
    5.84
    %
  Loans Held in DFR MM CLO
  67




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##### Table of Contents



WeightedCarrying
    
    
    AverageType of Loan
    
    Value
    
    
    Coupon(In thousands)First lien secured
    
    $
    78,853
    
    
    
    8.51
    %Second lien secured
    
    
    154,655
    
    
    
    9.81
    %Mezzanine
    
    
    23,310
    
    
    
    14.26
    %256,818
    
    
    
    9.82
    %Allowance for loan losses
    
    
    (6,750
    )$
    250,068
  Loans held in Wachovia Facility and Other Corporate Leveraged Loans
  Carrying ValueWeightedLoans Held
    
    
    
    
    
    
    
    
    
    
    AverageType of Loan
    
    for Sale (1)
    
    
    Loans
    
    
    Total
    
    
    Coupon(In thousands)First lien secured
    
    $
    10,200
    
    
    $
    2,087
    
    
    $
    12,287
    
    
    
    8.68
    %Second lien secured
    
    
    12,174
    
    
    
    44,865
    
    
    
    57,039
    
    
    
    10.08
    %Mezzanine
    
    
    
    
    
    
    17,851
    
    
    
    17,851
    
    
    
    17.48
    %Holding company
    
    
    
    
    
    
    22,758
    
    
    
    22,758
    
    
    
    11.78
    %$
    22,374
    
    
    $
    87,561
    
    
    
    109,935
    
    
    
    11.48
    %Allowance for loan losses
    
    
    
    
    
    
    (12,000
    )
    
    
    (12,000
    )$
    75,561
    
    
    $
    97,935
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value.  68




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##### Table of Contents



Commercial Real Estate Loans
  Preferred shares of CDOs
  Derivatives and Hedging
  Notional
    
    
    
    
    
    
    
    
    
    
    Estimated NetCount
    
    
    Amount
    
    
    Assets
    
    
    Liabilities
    
    
    Fair Value(In thousands)Interest rate swaps
    
    
    8
    
    
    $
    263,000
    
    
    $
    
    
    
    $
    (7,697
    )
    
    $
    (7,697
    )Interest rate cap
    
    
    1
    
    
    
    40,000
    
    
    
    
    
    
    
    (115
    )
    
    
    (115
    )Credit default
swaps  protection
seller
    
    
    1
    
    
    
    5,000
    
    
    
    
    
    
    
    (115
    )
    
    
    (115
    )Total return swaps
    
    
    1
    
    
    
    5,742
    
    
    
    499
    
    
    
    
    
    
    
    499Warrants
    
    
    3
    
    
    
    n/a
    
    
    
    1,505
    
    
    
    
    
    
    
    1,50514
    
    
    $
    313,742
    
    
    $
    2,004
    
    
    $
    (7,927
    )
    
    $
    (5,923
    )
 69




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##### Table of Contents



,
   Results of Operations
   70




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##### Table of Contents



Summary
  Three Months Ended
   
    Nine Months EndedSeptember 30,
    
    September 30,2008
    
    2007
    
    2008
    
    2007(In millions, except for per share data)Consolidated Statements of Operations Data:Net interest income
    
    $
    8.8
    
    
    $
    26.8
    
    
    $
    32.0
    
    
    $
    77.8Net interest (expense) income after provision
for loan losses
    
    $
    (6.6
    )
    
    $
    26.8
    
    
    $
    12.0
    
    
    $
    70.9Investment advisory fees
    
    $
    9.0
    
    
    $
    
    
    
    $
    33.5
    
    
    $
    Total expenses
    
    $
    122.8
    
    
    $
    5.1
    
    
    $
    183.8
    
    
    $
    16.9Net other income and (loss) gain
    
    $
    (31.8
    )
    
    $
    (45.3
    )
    
    $
    (476.1
    )
    
    $
    (40.3
    )Net (loss) income
    
    $
    (156.9
    )
    
    $
    (23.2
    )
    
    $
    (614.8
    )
    
    $
    13.8Net (loss) income per share  diluted
    
    $
    (22.81
    )
    
    $
    (4.50
    )
    
    $
    (95.52
    )
    
    $
    2.67Core earnings (1)
    
    $
    7.9
    
    
    $
    21.8
    
    
    $
    28.7
    
    
    $
    60.9Core earnings per share  diluted (1)
    
    $
    1.14
    
    
    $
    4.22
    
    
    $
    4.46
    
    
    $
    11.78Dividends:Dividends declared on common stock (2)
    
    $
    5.6
    
    
    $
    21.7
    
    
    $
    5.6
    
    
    $
    65.2Dividends declared per common share outstanding
    
    $
    0.85
    
    
    $
    4.20
    
    
    $
    0.85
    
    
    $
    12.60As of September 30,2008
    
    2007(In millions, except for per share data)Consolidated Balance Sheet Data:Residential mortgage-backed securities
    
    $
    414.5
    
    
    $
    7,390.6Total assets
    
    $
    1,221.3
    
    
    $
    8,745.4Repurchase agreements
    
    $
    383.6
    
    
    $
    6,811.2Long-term debt:Wachovia Facility
    
    $
    34.1
    
    
    $
    76.9Market Square CLO
    
    $
    276.0
    
    
    $
    276.0DFR MM CLO
    
    $
    231.0
    
    
    $
    231.0Trust preferred securities
    
    $
    123.7
    
    
    $
    123.7Series A Notes & Series B Notes
    
    $
    71.6
    
    
    $
    Pinetree CDO
    
    $
    
    
    
    $
    287.5Stockholders equity
    
    $
    63.4
    
    
    $
    550.7Metrics:Book value per share outstanding
    
    $
    9.50
    
    
    $
    106.40Economic book value per share outstanding (1)
    
    $
    12.23
    
    
    $
    90.71AUM:Investment Management segment (3) (4)
    
    $
    11,915.1
    
    
    $
    Principal Investing segment (5)
    
    $
    1,026.9
    
    
    $
    8,373.7
 
 (1)
    
    Represents a non-GAAP financial measure. Please see the Reconciliation of Non-GAAP
Financial Measures below for a reconciliation between the comparable GAAP measure and a
discussion of the importance placed on this measure by management.(2)
    
    Dividends shown for 2007 are reflected in the period to which they relate, rather than the
period declared. In addition, $1.7 million on account of accrued dividends on our Series A
cumulative convertible preferred stock issued in connection with the Merger and converted into
common stock in March 2008, or the Series A Preferred Stock, was distributed on October 15,
2008 and not included in this disclosure.(3)
    
    AUM for our Investment Management Segment includes CDO AUM numbers, which generally reflect
the aggregate principal or notional balance of the collateral and, in some cases, the cash
balance held by the CDOs as of the date of the last trustee report received for each CDO prior
to the relevant measurement date. The AUM for our Euro-denominated bank loan CDO has been
converted into U.S. dollars using the appropriate spot rate of exchange. AUM for our
Investment Management Segment also includes AUM for our separately managed accounts, which, in
certain cases, is a multiple of the capital actually invested in such account. Management fees
for these accounts are paid on this levered AUM number.(4)
    
    Included in the Investment Management segment AUM are $294.1 million and $300.9 million
related to Market Square CLO and DFR MM CLO, respectively, which amounts are also included in
the Principal Investing segment AUM. DCM manages these CDOs but is not contractually entitled
to receive any management fees for so long as 100% of the equity is held by DC LLC or an
affiliate thereof. All other amounts included in the Principal Investing segment AUM are
excluded from the Investment Management segment AUM.(5)
    
    AUM for the Principal Investing segment is reflected net of allowance for loan losses of
$21.6 million and $8.9 million as of September 30, 2008 and 2007, respectively. 71




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##### Table of Contents



Reconciliation of Non-GAAP Financial Measures
  Core Earnings
  Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands, except share and per share amounts)Net (loss) income
    
    $
    (156,883
    )
    
    $
    (23,235
    )
    
    $
    (614,801
    )
    
    $
    13,786Add back:Provision for loan losses
    
    
    15,459
    
    
    
    
    
    
    
    19,961
    
    
    
    6,933Depreciation and amortization
    
    
    2,498
    
    
    
    
    
    
    
    7,765
    
    
    
    Impairment of intangible assets and goodwill
    
    
    110,268
    
    
    
    
    
    
    
    139,302
    
    
    
    Net other income and (loss) gain
    
    
    31,795
    
    
    
    45,316
    
    
    
    476,105
    
    
    
    40,312Income tax expense (benefit)
    
    
    4,718
    
    
    
    (320
    )
    
    
    384
    
    
    
    (120
    )Core earnings
    
    $
    7,855
    
    
    $
    21,761
    
    
    $
    28,716
    
    
    $
    60,911Core earnings per share  diluted
    
    $
    1.14
    
    
    $
    4.22
    
    
    $
    4.46
    
    
    $
    11.78Weighted-average number of shares outstanding  diluted
    
    
    6,878,260
    
    
    
    5,161,811
    
    
    
    6,436,583
    
    
    
    5,170,557
 Economic Book Value Per Share
  As ofSeptember 30,
    
    
    December 31,2008
    
    
    2007(In thousands, except share and per share amounts)Stockholders Equity
    
    $
    63,368
    
    
    $
    468,574Add back:Negative Market Square CLO equity in excess of amount at risk
    
    
    18,210
    
    
    
    Economic book value
    
    $
    81,578
    
    
    $
    468,574Economic book value per share
    
    $
    12.23
    
    
    $
    90.71Total common shares outstanding
    
    
    6,669,742
    
    
    
    5,165,532
 72




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##### Table of Contents



Executive Summary
     73




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##### Table of Contents



Results of Operations by Segment
  Three months ended September 30, 2008Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    
    
    
    Consolidated(In thousands)Net revenues
    
    $
    9,566
    
    
    $
    (5,032
    )
    
    $
    (2,143
    )
    (1
    )
    
    
    $
    2,391Expenses
    
    
    (119,895
    )
    
    
    (5,009
    )
    
    
    2,143
    
    (1
    )
    
    
    
    (122,761
    )Other income and gain (loss)
    
    
    (552
    )
    
    
    (31,243
    )
    
    
    
    
    
    
    
    
    
    (31,795
    )Income tax (expense) benefit
    
    
    (8,302
    )
    
    
    3,584
    
    
    
    
    
    
    
    
    
    
    (4,718
    )Net loss
    
    $
    (119,183
    )
    
    $
    (37,700
    )
    
    $
    
    
    
    
    
    
    $
    (156,883
    )Nine months ended September 30, 2008Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    
    
    
    Consolidated(In thousands)Net revenues
    
    $
    39,369
    
    
    $
    16,676
    
    
    $
    (10,525
    )
    (1
    )
    
    
    $
    45,520Expenses
    
    
    (174,953
    )
    
    
    (19,404
    )
    
    
    10,525
    
    (1
    )
    
    
    
    (183,832
    )Other income and gain (loss)
    
    
    (3,534
    )
    
    
    (472,571
    )
    
    
    
    
    
    
    
    
    
    (476,105
    )Income tax expense
    
    
    (111
    )
    
    
    (273
    )
    
    
    
    
    
    
    
    
    
    (384
    )Net loss
    
    $
    (139,229
    )
    
    $
    (475,572
    )
    
    $
    
    
    
    
    
    
    $
    (614,801
    )
 
 (1)
    
    Represents the fees charged to the Principal Investing segment by the Investment Management
segment on a cost plus basis for investment advisory, management and operational services. Investment Management Segment
  Revenues
  Three months ended
    
    
    Nine months endedSeptember 30, 2008
    
    
    September 30, 2008(In thousands)Investment Management Segment RevenuesInterest income
    
    $
    127
    
    
    $
    624Interest expense
    
    
    1,719
    
    
    
    5,273Net interest expense
    
    
    (1,592
    )
    
    
    (4,649
    )Investment advisory fees (1)
    
    
    11,158
    
    
    
    44,018Total Investment Management segment revenues
    
    $
    9,566
    
    
    $
    39,369
 
 (1)
    
    Investment advisory fees include intercompany investment advisory fees of $2.1 million and
$10.5 million for the three and nine months ended September 30, 2008, respectively, calculated
in conjunction with our management agreement, which are eliminated upon consolidation. 74




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##### Table of Contents



Net Interest Income
  Investment Advisory Fees
  CDOs
  Three months ended September 30, 2008Senior
    
    
    Subordinated
    
    
    Performance
    
    
    
    
    
    
    Total CDOManagement Fees
    
    
    Management Fees
    
    
    Fees (1)
    
    
    
    
    
    
    Advisory Fees(In thousands)CLOs
    
    $
    2,027
    
    
    $
    3,376
    
    
    $
    
    
    
    
    
    
    
    $
    5,403ABS
    
    
    1,331
    
    
    
    64
    
    
    
    
    
    
    
    
    
    
    
    1,395Corporate bonds
    
    
    279
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    279Total CDOs
    
    $
    3,637
    
    
    $
    3,440
    
    
    $
    
    
    
    
    
    
    
    $
    7,077
 Nine months ended September 30, 2008Senior
    
    
    Subordinated
    
    
    Performance
    
    
    
    
    
    
    Total CDOManagement Fees
    
    
    Management Fees
    
    
    Fees (1)
    
    
    
    
    
    
    Advisory Fees(In thousands)CLOs
    
    $
    6,822
    
    
    $
    10,139
    
    
    $
    
    
    
    
    
    
    
    $
    16,961ABS
    
    
    4,157
    
    
    
    352
    
    
    
    2,774
    
    (2
    )
    
    
    
    
    7,283Corporate bonds
    
    
    731
    
    
    
    137
    
    
    
    
    
    
    
    
    
    
    
    868Total CDOs
    
    $
    11,710
    
    
    $
    10,628
    
    
    $
    2,774
    
    
    
    
    
    
    $
    25,112
 
 (1)
    
    Performance fees are generally earned after certain investors returns exceed a specified
internal rate of return, or IRR. For purposes of this and the following table, and in
accordance with our accounting policies, we also classify any previously deferred senior or
subordinated management fees that are subsequently paid as performance fees.(2)
    
    Performance fees for the nine months ended September 30, 2008 included a non-recurring
performance fee of $2.7 million received from one of our ABS CDOs. 75




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##### Table of Contents



Three months ended September 30, 2008Weighted AverageEffective Rate (2)
    
    
    Contractual Rate (3)Senior
    
    
    Subordinated
    
    
    Senior
    
    
    SubordinatedAverage AUM (1)
    
    
    Management Fee
    
    
    Management Fee
    
    
    Management Fee
    
    
    Management Fee(In thousands)CLOs (4)
    
    $
    4,529,916
    
    
    
    0.18
    %
    
    
    0.30
    %
    
    
    0.20
    %
    
    
    0.30
    %ABS:High-grade ABS
    
    
    3,558,890
    
    
    
    0.05
    %
    
    
    0.00
    %
    
    
    0.05
    %
    
    
    0.06
    %Other ABS
    
    
    2,593,805
    
    
    
    0.14
    %
    
    
    0.01
    %
    
    
    0.14
    %
    
    
    0.19
    %Total ABS
    
    
    6,152,695
    
    
    
    0.09
    %
    
    
    0.00
    %
    
    
    0.09
    %
    
    
    0.11
    %Corporate bonds (5)
    
    
    743,599
    
    
    
    0.15
    %
    
    
    0.00
    %
    
    
    0.20
    %
    
    
    0.17
    %Total CDOs
    
    $
    11,426,210
    
    
    
    0.13
    %
    
    
    0.12
    %
    
    
    0.14
    %
    
    
    0.19
    %
 Nine months ended September 30, 2008Weighted AverageEffective Rate (2)
    
    
    Contractual Rate (3)Senior
    
    
    Subordinated
    
    
    Senior
    
    
    SubordinatedAverage AUM (1)
    
    
    Management Fee
    
    
    Management Fee
    
    
    Management Fee
    
    
    Management Fee(In thousands)CLOs (4)
    
    $
    4,943,179
    
    
    
    0.18
    %
    
    
    0.27
    %
    
    
    0.20
    %
    
    
    0.29
    %ABS:High-grade ABS
    
    
    3,661,811
    
    
    
    0.05
    %
    
    
    0.00
    %
    
    
    0.05
    %
    
    
    0.06
    %Other ABS
    
    
    2,822,902
    
    
    
    0.13
    %
    
    
    0.01
    %
    
    
    0.14
    %
    
    
    0.19
    %Total ABS
    
    
    6,484,713
    
    
    
    0.09
    %
    
    
    0.01
    %
    
    
    0.09
    %
    
    
    0.11
    %Corporate bonds (5)
    
    
    673,826
    
    
    
    0.13
    %
    
    
    0.03
    %
    
    
    0.20
    %
    
    
    0.19
    %Total CDOs
    
    $
    12,101,718
    
    
    
    0.13
    %
    
    
    0.12
    %
    
    
    0.14
    %
    
    
    0.19
    %
 
 (1)
    
    Average AUM is calculated as the average of the July 1, August 1 and September 1, 2008 AUM
for the three months ended September 30, 2008 and the average of the January 1, February 1,
March 1, April 1, May 1, June 1, July 1, August 1 and September 1, 2008 AUM for the nine
months ended September 30, 2008. CDO AUM numbers generally reflect the aggregate principal or
notional balance of the collateral and, in some cases, the cash balance held by the CDO and
are as of the date of the last trustee report received for each CDO prior to the AUM date, as
appropriate. Our bank loans AUM total includes AUM related to our bank loan CDOs and
structured loan fund.(2)
    
    The effective rate for the three months ended September 30, 2008 is calculated by taking the
management fees earned during the three months ended September 30, 2008 multiplied by four (to
annualize) and divided by the average AUM. The effective rate for the nine months ended
September 30, 2008 is calculated by taking management fees earned during the period multiplied
by 1.33 (to annualize) and divided by the average AUM. The senior and subordinated management
fee effective rates may differ from the contractual fee rates for various reasons, including
the following: (a) we may have entered into agreement with specific investors pursuant to
which our management fees are paid to those investors and (b) our senior or subordinated
management fees may be deferred as a result of certain structural provisions built into the
documents governing the CDO. In certain circumstances, we may at a later date, subject to
certain performance triggers, be entitled to repayment of the fees paid to investors described
in (a) above. In addition, we may at a later date, subject to the satisfaction of certain
structural provisions, be entitled to payment of the deferred fees described in (b) above.(3)
    
    The weighted average contractual senior and subordinated management fee rates are obtained by
multiplying the contractual fee rates for each CDO by that CDOs average AUM and dividing that
number by the total average AUM for the relevant asset class.(4)
    
    The AUM for our Euro-denominated CLOs have been converted to U.S. dollars using the spot rate
of exchange as of the respective AUM date. Market Square CLO and DFR MM CLO have been excluded
from all categories in this table as DCM manages these CLOs, but is not contractually entitled
to receive any third party management fees as long as 100% of the equity is held by DC LLC or
an affiliate thereof.(5)
    
    The effective and contractual rates for Robeco CDO are calculated based on the fees that we
are entitled to receive pursuant to the asset purchase agreement between DCM and Robeco
Investment Management, Inc. and are not the total fees paid by the CDO or the contractual fee
rate set forth in the management agreement. 76




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##### Table of Contents



Termination ofFirst Optional
    
    
    Auction Call
    
    
    Reinvestment
    
    
    MaturityClosing Date
    
    
    October 1, 2008 AUM (1)
    
    
    Call Date (2)
    
    
    Date (3)
    
    
    Period (4)
    
    
    YearMonth/Year
    
    
    (In thousands)
    
    
    Month/YearCLOs:Rosemont CLO, Ltd.
    
    
    01/02
    
    
    $
    178,218
    
    
    
    10/05
    
    
    
    n/a
    
    
    
    01/07
    
    
    
    2013Forest Creek CLO Ltd.
    
    
    05/03
    
    
    
    323,586
    
    
    
    07/07
    
    
    
    n/a
    
    
    
    07/08
    
    
    
    2015Long Grove CLO Ltd.
    
    
    06/04
    
    
    
    400,779
    
    
    
    08/08
    
    
    
    n/a
    
    
    
    05/10
    
    
    
    2016Access Institutional Loan
Fund (5)
    
    
    08/04
    
    
    
    124,915
    
    
    Variable
    
    
    n/a
    
    
    
    n/a
    
    
    
    2009Market Square CLO Ltd. (6)
    
    
    05/05
    
    
    
    294,059
    
    
    
    07/07
    
    
    
    n/a
    
    
    
    04/11
    
    
    
    2017Cumberland II CLO Ltd.
    
    
    09/05
    
    
    
    390,097
    
    
    
    02/10
    
    
    
    n/a
    
    
    
    11/11
    
    
    
    2019Marquette Park CLO Ltd.
    
    
    12/05
    
    
    
    301,557
    
    
    
    04/10
    
    
    
    n/a
    
    
    
    01/12
    
    
    
    2020Bridgeport CLO Ltd.
    
    
    06/06
    
    
    
    503,792
    
    
    
    10/09
    
    
    
    n/a
    
    
    
    07/13
    
    
    
    2020Burr Ridge CLO Plus Ltd.
    
    
    12/06
    
    
    
    301,474
    
    
    
    06/12
    
    
    
    n/a
    
    
    
    03/13
    
    
    
    2023Schiller Park CLO Ltd.
    
    
    05/07
    
    
    
    388,999
    
    
    
    07/11
    
    
    
    n/a
    
    
    
    04/13
    
    
    
    2021Bridgeport CLO II Ltd.
    
    
    06/07
    
    
    
    503,609
    
    
    
    12/10
    
    
    
    n/a
    
    
    
    09/14
    
    
    
    2021DFR Middle Market CLO
Ltd. (6)
    
    
    07/07
    
    
    
    300,939
    
    
    
    07/10
    
    
    
    n/a
    
    
    
    07/10
    
    
    
    2019Bryn Mawr CLO II Ltd. (5)
    
    
    07/07
    
    
    
    322,070
    
    
    
    08/13
    
    
    
    n/a
    
    
    
    08/14
    
    
    
    2019Gillespie CLO PLC (8)
    
    
    08/07
    
    
    
    404,756
    
    
    
    02/13
    
    
    
    n/a
    
    
    
    08/13
    
    
    
    2023Total CLOs
    
    
    
    
    
    
    4,738,850ABS CDOs:Mid Ocean CBO 2000-1 Ltd.
    
    
    01/01
    
    
    
    126,248
    
    
    
    04/06
    
    
    
    n/a
    
    
    
    01/06
    
    
    
    2036Mid Ocean CBO 2001-1 Ltd.
    
    
    10/01
    
    
    
    138,945
    
    
    
    02/06
    
    
    
    n/a
    
    
    
    01/06
    
    
    
    2036Oceanview CBO I, Ltd.
    
    
    06/02
    
    
    
    203,854
    
    
    
    06/06
    
    
    
    06/12
    
    
    
    06/06
    
    
    
    2032,2037
    (7)Northlake CDO I, Limited
    
    
    02/03
    
    
    
    184,113
    
    
    
    03/06
    
    
    
    03/13
    
    
    
    03/07
    
    
    
    2033Knollwood CDO Ltd.
    
    
    03/04
    
    
    
    228,225
    
    
    
    04/07
    
    
    
    04/12
    
    
    
    04/08
    
    
    
    2039River North CDO Ltd.
    
    
    01/05
    
    
    
    276,055
    
    
    
    02/09
    
    
    
    02/13
    
    
    
    02/09
    
    
    
    2040Buckingham CDO Ltd.
    
    
    07/05
    
    
    
    864,218
    
    
    
    08/10
    
    
    
    08/13
    
    
    
    08/10
    
    
    
    2040Pinetree CDO Ltd.
    
    
    11/05
    
    
    
    263,452
    
    
    
    01/10
    
    
    
    01/14
    
    
    
    01/10
    
    
    
    2045Buckingham CDO II Ltd.
    
    
    12/05
    
    
    
    1,243,560
    
    
    
    03/11
    
    
    
    03/14
    
    
    
    03/11
    
    
    
    2041Knollwood CDO II Ltd.
    
    
    07/06
    
    
    
    606,024
    
    
    
    07/09
    
    
    
    07/13
    
    
    
    n/a
    
    
    
    2046Buckingham CDO III Ltd.
    
    
    08/06
    
    
    
    1,412,670
    
    
    
    09/11
    
    
    
    09/14
    
    
    
    09/11
    
    
    
    2051Aramis CDO
    
    
    03/07
    
    
    
    233,444
    
    
    
    03/12
    
    
    
    n/a
    
    
    
    n/a
    
    
    
    2047Total ABS CDOs
    
    
    
    
    
    
    5,780,808Corporate Bond CDOs:Valeo Investment Grade CDO Ltd.
    
    
    01/01
    
    
    
    302,168
    
    
    
    01/05
    
    
    
    n/a
    
    
    
    01/06
    
    
    
    2013Valeo Investment Grade CDO
II Ltd.
    
    
    05/01
    
    
    
    312,733
    
    
    
    06/05
    
    
    
    n/a
    
    
    
    06/06
    
    
    
    2013Robeco CDO II Limited (9)
    
    
    08/01
    
    
    
    182,238
    
    
    
    08/05
    
    
    
    n/a
    
    
    
    02/06
    
    
    
    2013Total Corporate Bond CDOs
    
    
    
    
    
    
    797,139Total CDO AUM
    
    
    
    
    
    $
    11,316,797
 
 (1)
    
    CDO AUM numbers generally reflect the aggregate principal or notional balance of the
collateral and, in some cases, the cash balance held by the CDOs and are as of the date of the
last trustee report received for each CDO prior to October 1, 2008.(2)
    
    CDOs are generally callable by equity holders once per quarter beginning on the first option
call date and subject to satisfaction of certain conditions.(3)
    
    Asset-Backed CDOs generally contain a provision requiring the manager thereof to liquidate
the collateral held therein on the auction call date, subject to certain conditions,
generally including that the proceeds from any such liquidation be sufficient to redeem the
notes and pay certain additional expenses.(4)
    
    Termination of reinvestment period refers to the date after which we can no longer use
certain principal collections to purchase additional collateral, and such collections are
instead used to deleverage the CDO.(5)
    
    Market value CLOs.(6)
    
    We are not contractually entitled to receive any management fees from these CLOs as long as
100% of the equity is held by DC LLC or an affiliate thereof.(7)
    
    Maturity date varies by tranche of notes.(8)
    
    The AUM for our Euro-denominated CLO has been converted into U.S. dollars using the spot rate
of exchange on September 30, 2008.(9)
    
    Represents the asset management contract acquired from Robeco Investment Management, Inc. on
July 17, 2008. 77




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78




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##### Table of Contents



Investment Funds and Separately Managed Accounts
  Three months ended September 30, 2008
    
    Nine months ended September 30, 2008Average
    
    Management
    
    Performance
    
    Average
    
    Management
    
    PerformanceAUM (1)
    
    Fees
    
    Fees
    
    AUM (2)
    
    Fees
    
    Fees(In thousands)Fixed income arbitrage 
investment funds
    
    $
    435,676
    
    
    $
    1,702
    
    
    $
    
    
    
    $
    550,859
    
    
    $
    6,450
    
    
    $
    1,186
    (3)Separately managed accounts
    
    $
    404,321
    
    
    $
    236
    
    
    
    n/a
    
    
    $
    410,542
    
    
    $
    745
    
    
    
    n/a
 
 (1)
    
    Average AUM is calculated as the average of the AUM on July 1, August 1 and September 1,
2008.(2)
    
    Average AUM is calculated as the average of the AUM on January 1, February 1, March 1, April
1, May 1, June 1, July 1, August 1 and September 1, 2008.(3)
    
    Performance fees were related to our smaller investment fund which liquidated on April 30,
2008.n/a
    
     not applicable    Intercompany investment advisory fees
  79




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##### Table of Contents



Expenses
  Three Months
    
    
    Nine Monthsended September 30, 2008(In millions)Salaries
    
    $
    3.3
    
    
    $
    11.0Incentive compensation
    
    
    1.2
    
    
    
    9.4Employee benefits
    
    
    0.5
    
    
    
    1.4Severance expense
    
    
    
    
    
    
    0.3Total compensation and benefits
    
    
    5.0
    
    
    
    22.1Fixed asset depreciation
    
    
    0.3
    
    
    
    1.0Intangible asset amortization
    
    
    2.2
    
    
    
    6.8Total depreciation and amortization
    
    
    2.5
    
    
    
    7.8Audit and audit-related fees
    
    
    0.1
    
    
    
    0.5Legal fees
    
    
    0.4
    
    
    
    0.5Other professional fees
    
    
    0.1
    
    
    
    0.2Total professional services
    
    
    0.6
    
    
    
    1.2Insurance expense
    
    
    0.1
    
    
    
    0.4Rent expense
    
    
    0.6
    
    
    
    1.9Software and data feeds
    
    
    0.5
    
    
    
    1.5Other general and administrative fees
    
    
    0.3
    
    
    
    0.8Total general and administrative expense
    
    
    1.4
    
    
    
    4.2Impairment of intangible assets
    
    
    32.2
    
    
    
    41.2Impairment of goodwill
    
    
    78.1
    
    
    
    98.1Total impairment of intangible assets and goodwill
    
    
    110.3
    
    
    
    139.3Total Investment Management segment expenses
    
    $
    119.9
    
    
    $
    175.0
 See Item 5. Other Information
 80




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##### Table of Contents



Other Income and Gain (Loss)
  Income Tax Expense
 Income Taxes
 81




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##### Table of Contents



Principal Investing Segment
 Revenues
  Three months ended September 30,
    
    
    Variance
    
    
    Nine months ended September 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Principal Investing Segment RevenuesInterest income
    
    $
    20.4
    
    
    $
    125.8
    
    
    $
    (105.4
    )
    
    $
    103.1
    
    
    $
    378.2
    
    
    $
    (275.1
    )Interest expense
    
    
    9.9
    
    
    
    99.0
    
    
    
    89.1
    
    
    
    66.4
    
    
    
    300.3
    
    
    
    233.9Net interest income
    
    
    10.5
    
    
    
    26.8
    
    
    
    (16.3
    )
    
    
    36.7
    
    
    
    77.9
    
    
    
    (41.2
    )Provision for loan losses
    
    
    15.5
    
    
    
    
    
    
    
    (15.5
    )
    
    
    20.0
    
    
    
    6.9
    
    
    
    (13.1
    )Total Principal Investing segment revenues
    
    $
    (5.0
    )
    
    $
    26.8
    
    
    $
    (31.8
    )
    
    $
    16.7
    
    
    $
    71.0
    
    
    $
    (54.3
    )
  Three months ended September 30,
    
    
    Variance
    
    
    % of total interest income2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    Three months ended September 30,(In millions)
    
    
    2008
    
    
    2007RMBS
    
    $
    5.7
    
    
    $
    96.6
    
    
    $
    (90.9
    )
    
    
    27.9
    %
    
    
    76.7
    %Corporate loans and securities:Assets held in DFR MM CLO
    
    
    6.8
    
    
    
    7.8
    
    
    
    (1.0
    )
    
    
    33.3
    %
    
    
    6.2
    %Assets held in Wachovia Facility
    
    
    2.2
    
    
    
    6.8
    
    
    
    (4.6
    )
    
    
    10.8
    %
    
    
    5.4
    %Other corporate leveraged loans
    
    
    0.9
    
    
    
    0.7
    
    
    
    0.2
    
    
    
    4.4
    %
    
    
    0.6
    %High yield corporate bonds
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    0.0
    %
    
    
    0.1
    %Assets held in Market Square CLO
    
    
    4.2
    
    
    
    6.0
    
    
    
    (1.8
    )
    
    
    20.6
    %
    
    
    4.8
    %ABS held in Pinetree CDO
    
    
    
    
    
    
    5.5
    
    
    
    (5.5
    )
    
    
    0.0
    %
    
    
    4.4
    %Commercial real estate loans and securities
    
    
    0.4
    
    
    
    1.4
    
    
    
    (1.0
    )
    
    
    2.0
    %
    
    
    1.1
    %Treasuries and short-term investments
    
    
    0.2
    
    
    
    0.8
    
    
    
    (0.6
    )
    
    
    1.0
    %
    
    
    0.6
    %Other investments
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    0.0
    %
    
    
    0.1
    %Total interest income
    
    $
    20.4
    
    
    $
    125.8
    
    
    $
    (105.4
    )
    
    
    100.0
    %
    
    
    100.0
    %
 Nine months ended September 30,
    
    
    Variance
    
    
    % of total interest income2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    Nine months ended September 30,(In millions)
    
    
    2008
    
    
    2007RMBS
    
    $
    53.8
    
    
    $
    292.4
    
    
    $
    (238.6
    )
    
    
    52.2
    %
    
    
    77.3
    %Corporate loans and securities:Assets held in DFR MM CLO
    
    
    22.0
    
    
    
    7.8
    
    
    
    14.2
    
    
    
    21.3
    %
    
    
    2.1
    %Assets held in Wachovia Facility
    
    
    8.4
    
    
    
    35.0
    
    
    
    (26.6
    )
    
    
    8.1
    %
    
    
    9.3
    %Other corporate leveraged loans
    
    
    1.6
    
    
    
    2.3
    
    
    
    (0.7
    )
    
    
    1.6
    %
    
    
    0.5
    %High yield corporate bonds
    
    
    
    
    
    
    0.7
    
    
    
    (0.7
    )
    
    
    0.0
    %
    
    
    0.2
    %Assets held in Market Square CLO
    
    
    13.7
    
    
    
    17.4
    
    
    
    (3.7
    )
    
    
    13.3
    %
    
    
    4.5
    %ABS held in Pinetree CDO
    
    
    
    
    
    
    16.2
    
    
    
    (16.2
    )
    
    
    0.0
    %
    
    
    4.3
    %Commercial real estate loans and securities
    
    
    2.2
    
    
    
    4.4
    
    
    
    (2.2
    )
    
    
    2.1
    %
    
    
    1.2
    %Treasuries and short-term investments
    
    
    1.3
    
    
    
    1.8
    
    
    
    (0.5
    )
    
    
    1.3
    %
    
    
    0.5
    %Other investments
    
    
    0.1
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.1
    %
    
    
    0.1
    %Total interest income
    
    $
    103.1
    
    
    $
    378.2
    
    
    $
    (275.1
    )
    
    
    100.0
    %
    
    
    100.0
    %
  82




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##### Table of Contents



Three months ended September 30,
    
    
    Variance
    
    
    Nine months ended September 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Repurchase agreements
    
    $
    2.8
    
    
    $
    97.0
    
    
    $
    (94.2
    )
    
    $
    37.2
    
    
    $
    295.0
    
    
    $
    (257.8
    )Hedging activity
    
    
    
    
    
    
    (15.3
    )
    
    
    15.3
    
    
    
    5.3
    
    
    
    (44.3
    )
    
    
    49.6Long term debtWachovia Facility
    
    
    0.3
    
    
    
    2.1
    
    
    
    (1.8
    )
    
    
    1.5
    
    
    
    10.0
    
    
    
    (8.5
    )Market Square CLO
    
    
    2.3
    
    
    
    4.1
    
    
    
    (1.8
    )
    
    
    8.0
    
    
    
    12.2
    
    
    
    (4.2
    )DFR MM CLO
    
    
    2.0
    
    
    
    3.0
    
    
    
    (1.0
    )
    
    
    7.1
    
    
    
    3.0
    
    
    
    4.1Pinetree CDO
    
    
    
    
    
    
    4.3
    
    
    
    (4.3
    )
    
    
    
    
    
    
    12.9
    
    
    
    (12.9
    )Trust preferred securities
    
    
    1.8
    
    
    
    2.6
    
    
    
    (0.8
    )
    
    
    5.7
    
    
    
    7.6
    
    
    
    (1.9
    )Total long term debt
    
    
    6.4
    
    
    
    16.1
    
    
    
    (9.7
    )
    
    
    22.3
    
    
    
    45.7
    
    
    
    (23.4
    )Amortization of debt issuance cost
    
    
    0.7
    
    
    
    1.1
    
    
    
    (0.4
    )
    
    
    1.6
    
    
    
    3.6
    
    
    
    (2.0
    )Margin borrowing
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )Total interest expense
    
    $
    9.9
    
    
    $
    98.9
    
    
    $
    (89.0
    )
    
    $
    66.4
    
    
    $
    300.3
    
    
    $
    (233.9
    )
     Principal Investing Segment  Wachovia Facility
 83




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##### Table of Contents



Provision for Loan Losses
  Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In millions)Loans held in DFR MM CLO
    
    $
    6.8
    
    
    $
    
    
    
    $
    6.8
    
    
    $
    Loans held in Wachovia Facility
    
    
    6.2
    
    
    
    
    
    
    
    6.2
    
    
    
    6.9Other corporate leveraged loans
    
    
    
    
    
    
    
    
    
    
    2.2
    
    
    
    Commercial real estate loans
    
    
    2.5
    
    
    
    
    
    
    
    4.8
    
    
    
    Total provision for loan losses
    
    $
    15.5
    
    
    $
    
    
    
    $
    20.0
    
    
    $
    6.9
      84




---



##### Table of Contents



Expenses
  Three months ended September 30,
    
    
    Variance
    
    
    Nine months ended September 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Base management fee expense (1)
    
    $
    2.1
    
    
    $
    3.2
    
    
    $
    (1.1
    )
    
    $
    10.5
    
    
    $
    9.8
    
    
    $
    0.7Amortization related to restricted stock and options
    
    
    
    
    
    
    (0.4
    )
    
    
    0.4
    
    
    
    
    
    
    
    (0.3
    )
    
    
    0.3Total management expense to related party
    
    
    2.1
    
    
    
    2.8
    
    
    
    (0.7
    )
    
    
    10.5
    
    
    
    9.5
    
    
    
    1.0Incentive fee expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.2
    
    
    
    (2.2
    )Audit and audit-related fees
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.1
    
    
    
    1.3
    
    
    
    0.9
    
    
    
    0.4Legal fees
    
    
    1.1
    
    
    
    0.4
    
    
    
    0.7
    
    
    
    2.8
    
    
    
    0.7
    
    
    
    2.1Other professional fees
    
    
    0.1
    
    
    
    0.7
    
    
    
    (0.6
    )
    
    
    0.6
    
    
    
    1.2
    
    
    
    (0.6
    )Total professional services
    
    
    1.6
    
    
    
    1.4
    
    
    
    0.2
    
    
    
    4.7
    
    
    
    2.8
    
    
    
    1.9Insurance expense
    
    
    0.6
    
    
    
    0.2
    
    
    
    0.4
    
    
    
    1.8
    
    
    
    0.5
    
    
    
    1.3Board of directors fees
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.1
    
    
    
    1.5
    
    
    
    0.9
    
    
    
    0.6Banking and other administrative fees
    
    
    0.1
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.5
    
    
    
    0.5
    
    
    
    Software and data feeds
    
    
    
    
    
    
    0.2
    
    
    
    (0.2
    )
    
    
    0.2
    
    
    
    0.3
    
    
    
    (0.1
    )Other general and administrative fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.2
    
    
    
    0.2
    
    
    
    Total general and administrative expense
    
    
    0.5
    
    
    
    0.7
    
    
    
    (0.2
    )
    
    
    2.4
    
    
    
    1.9
    
    
    
    0.5Total Principal Investing segment expenses
    
    $
    4.8
    
    
    $
    5.1
    
    
    $
    (0.3
    )
    
    $
    19.4
    
    
    $
    16.9
    
    
    $
    2.5
 
 (1)
    
    Base management fee expense for the three and nine months ended September 30, 2008 includes
$2.1 million and $10.5 million, respectively, of management fee expense in conjunction with
our new management agreement with DCM, which is eliminated in consolidation.   85




---



##### Table of Contents

\

Other Income and (Loss) Gain
  Three months ended September 30,
    
    
    Variance
    
    
    Nine months ended September 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Net realized loss on available-for-sale securities
    
    $
    
    
    
    $
    (6.8
    )
    
    $
    6.8
    
    
    $
    
    
    
    $
    (4.3
    )
    
    $
    4.3Other-than-temporary impairment on available-for-sale securities
    
    
    (0.9
    )
    
    
    (16.4
    )
    
    
    15.5
    
    
    
    (4.7
    )
    
    
    (16.6
    )
    
    
    11.9Net loss on available-for-sale securities
    
    
    (0.9
    )
    
    
    (23.2
    )
    
    
    22.3
    
    
    
    (4.7
    )
    
    
    (20.9
    )
    
    
    16.2Net realized gain (loss) on trading securities
    
    
    0.1
    
    
    
    (2.5
    )
    
    
    2.6
    
    
    
    (169.1
    )
    
    
    (2.1
    )
    
    
    (167.0
    )Net unrealized (loss) gain on trading securities
    
    
    (13.3
    )
    
    
    8.1
    
    
    
    (21.4
    )
    
    
    (43.6
    )
    
    
    4.7
    
    
    
    (48.3
    )Net (loss) gain on trading securities
    
    
    (13.2
    )
    
    
    5.6
    
    
    
    (18.8
    )
    
    
    (212.7
    )
    
    
    2.6
    
    
    
    (215.3
    )Net realized gain (loss) on loans and loans held for sale
    
    
    0.6
    
    
    
    0.4
    
    
    
    0.2
    
    
    
    (12.0
    )
    
    
    0.5
    
    
    
    (12.5
    )Net unrealized loss on loans and loans held for sale
    
    
    (15.0
    )
    
    
    (7.8
    )
    
    
    (7.2
    )
    
    
    (23.4
    )
    
    
    (7.5
    )
    
    
    (15.9
    )Net loss on loans and loans held for sale
    
    
    (14.4
    )
    
    
    (7.4
    )
    
    
    (7.0
    )
    
    
    (35.4
    )
    
    
    (7.0
    )
    
    
    (28.4
    )Net realized gain (loss) on interest rate swaps
    
    
    0.2
    
    
    
    (3.2
    )
    
    
    3.4
    
    
    
    (271.9
    )
    
    
    0.3
    
    
    
    (272.2
    )Net realized gain (loss) on credit default swaps
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )
    
    
    (2.4
    )
    
    
    1.5
    
    
    
    (3.9
    )Net realized (loss) gain on total return swaps
    
    
    (1.5
    )
    
    
    0.8
    
    
    
    (2.3
    )
    
    
    (2.2
    )
    
    
    1.0
    
    
    
    (3.2
    )Net realized gain (loss) on interest rate caps and floors
    
    
    
    
    
    
    1.5
    
    
    
    (1.5
    )
    
    
    (1.6
    )
    
    
    1.5
    
    
    
    (3.1
    )Net unrealized (loss) gain on interest rate swaps
    
    
    (1.8
    )
    
    
    (12.0
    )
    
    
    10.2
    
    
    
    55.8
    
    
    
    (13.3
    )
    
    
    69.1Net unrealized (loss) gain on credit default swaps
    
    
    
    
    
    
    (0.6
    )
    
    
    0.6
    
    
    
    0.4
    
    
    
    (0.8
    )
    
    
    1.2Net unrealized gain (loss) on total return swaps
    
    
    0.9
    
    
    
    (3.0
    )
    
    
    3.9
    
    
    
    1.2
    
    
    
    (2.6
    )
    
    
    3.8Net
unrealized (loss) gain on interest rate caps and floors
    
    
    
    
    
    
    (3.9
    )
    
    
    3.9
    
    
    
    1.1
    
    
    
    (2.3
    )
    
    
    3.4Net unrealized gain (loss) on warrants
    
    
    
    
    
    
    (0.1
    )
    
    
    0.1
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.3Net loss on derivatives
    
    
    (2.2
    )
    
    
    (20.2
    )
    
    
    18.0
    
    
    
    (219.4
    )
    
    
    (14.8
    )
    
    
    (204.6
    )Dividend income
    
    
    0.2
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.4
    
    
    
    0.2
    
    
    
    0.2Other net loss
    
    
    (0.9
    )
    
    
    (0.2
    )
    
    
    (0.7
    )
    
    
    (0.9
    )
    
    
    (0.4
    )
    
    
    (0.5
    )Dividend income and other net loss
    
    
    (0.7
    )
    
    
    (0.1
    )
    
    
    (0.6
    )
    
    
    (0.5
    )
    
    
    (0.2
    )
    
    
    (0.3
    )Net other income and (loss) gain
    
    $
    (31.4
    )
    
    $
    (45.3
    )
    
    $
    13.9
    
    
    $
    (472.7
    )
    
    $
    (40.3
    )
    
    $
    (432.4
    )Total realized loss
    
    $
    (1.3
    )
    
    $
    (9.4
    )
    
    $
    8.1
    
    
    $
    (459.7
    )
    
    $
    (1.4
    )
    
    $
    (458.3
    )Total unrealized loss
    
    $
    (30.1
    )
    
    $
    (35.9
    )
    
    $
    5.8
    
    
    $
    (13.0
    )
    
    $
    (38.9
    )
    
    $
    25.9
   86




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##### Table of Contents



Income Tax Expense
 Income Taxes
 Off-Balance Sheet Arrangements
  Liquidity and Capital Resources
    
    
    Net sales of trading securities  $658.2 million
    
    Net loss from trading securities  $216.1 million
    
    Impairment on intangible assets and goodwill  $139.3 million
    
    Amortization of net loss on previously designated derivatives  $96.9 million
    
    Net change in operating assets and liabilities  $75.0 million
    
    Net loss on loans and loans held for sale  $35.4 million
    
    Provision for loan losses  $20.0 million
    
    Depreciation, amortization and non-cash expenses  $7.8 million
    
    Other-than-temporary impairment on available-for-sale securities  $4.7 million
    
    Net premium and discount amortization on investments, loan and debt issuance
costs  $2.3 million
    
    Net loss on other investments  $0.7 million
    
    Share-based compensation  $0.5 million
 87




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##### Table of Contents




    
    Deferred tax benefit  $0.4 million
    
    Non-cash rental expense $0.1 millionNet outflows and non-cash adjustments totaled $783.1 million, consisting of the following:
 
    
    Net loss  $614.8 million
    
    Net changes in undesignated derivatives  $159.0 million
    
    Net purchases of loans held for sale  $9.3 million
   Leverage
 Liquidity and Sources of FundsPrincipal
Investing SegmentWachovia Facility
  Liquidity and Sources of Funds
  88




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##### Table of Contents



Investment Management Segment
  SeriesShort Term
    
    A & BDebt (1)
    
    Notes
    
    Total(In thousands)Outstanding balance
    
    $
    172
    
    
    $
    71,631
    (2)
    
    $
    71,803Weighted average borrowing rate
    
    
    5.78
    %
    
    
    7.79
    %
    
    
    7.79
    %Weighted-average remaining maturity (in years)
    
    
    0.67
    (3)
    
    
    4.25
    
    
    
    4.24Carrying value of collateral (including accrued interest)
    
    $
    
    
    
    $
    71,588
    (4)
    
    $
    71,588
 
 (1)
    
    The short term debt consists of one limited recourse note collateralized by the investment in
preferred shares of a CDO.(2)
    
    Principal outstanding of $71.6 million is presented net of a $2.3 million discount.(3)
    
    Based on contractual maturity.(4)
    
    Includes the assets of Deerfield, as issuer of the Series A and Series B Notes, but does not
include the assets of any guarantors thereof.  89




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##### Table of Contents



Principal Investing Segment
  TrustRepurchase
    
    Term
    
    Wachovia
    
    PreferredAgreements
    
    Financing
    
    Facility
    
    Securities
    
    Total(In thousands)Outstanding balance
    
    $
    383,617
    
    
    $
    507,000
    (1)
    
    $
    34,060
    
    
    $
    123,717
    
    
    $
    1,048,393Weighted average borrowing rate
    
    
    3.46
    %
    
    
    3.37
    %
    
    
    5.10
    %
    
    
    5.57
    %
    
    
    3.72
    %Weighted-average remaining maturity (in years)
    
    
    0.03
    
    
    
    9.58
    (2)
    
    
    0.44
    
    
    
    27.68
    (3)
    
    
    8.00Carrying value of collateral (including accrued interest)
    
    $
    408,660
    
    
    $
    562,608
    
    
    $
    76,740
    
    
    
    n/a
    
    
    $
    1,048,009
 
 n/a
    
     not applicable(1)
    
    Excludes $19.0 million of DFR MM CLO debt that is owned by us and eliminated upon
consolidation. Had this debt been included, the weighted-average borrowing rate would be
3.49%, and the weighted-average remaining maturity would be 9.63 years.(2)
    
    $276.0 million of the term financing is callable quarterly by us, and $231.0 million is
callable after July 20, 2010 and quarterly thereafter.(3)
    
    $51.6 million of the trust preferred securities are callable by us after October 30, 2010,
and $72.1 million are callable by us after October 30, 2011. Repurchase Agreements
  90




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##### Table of Contents



Weighted-AverageMaturity ofRepurchaseAmount at Risk (1)
    
    
    AgreementsCounterparties:
    
    (In thousands)
    
    
    (In days)Bank of America Securities LLC
    
    $
    9,219
    
    
    
    1Deutsche Bank Securities Inc.
    
    
    6,655
    
    
    
    1Fortis Securities LLC
    
    
    8,455
    
    
    
    14HSBC Securities (USA), Inc.
    
    
    1,778
    
    
    
    3Total
    
    $
    26,107
    
    
    
    11
 
 (1)
    
    Equal to the fair value of securities pledged (including net additional repurchase
agreement collateral pledged of $1.1 million), minus repurchase agreement liabilities and
related accrued interest payable.  Wachovia Facility
   91




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##### Table of Contents



Trust Preferred Securities
   Recent Developments
 92




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##### Table of Contents



Distribution Policy
  Recent Developments
 Reverse Stock Split
  Stock Repurchase
  Trust Preferred Securities
  Cost Savings Initiative
 Item
5. Other Information
 Inflation
  93




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##### Table of Contents



Seasonality
  
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Interest Rate Risk
  Effect on Net Interest Income
   NotionalAmountYear
of Expiration

    
    (In thousands)2009
    
    $
    110,0002010
    
    
    78,0002012
    
    
    50,0002018
    
    
    25,000Total
    
    $
    263,000
  94




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Extension Risk
   Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk
  Interest Rate Mismatch Risk
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Prepayment Risk
  Effect on Fair Value
    Interest Rates
    
    
    
    
    
    Interest RatesFall 100
    
    
    
    
    
    Rise 100Basis Points
    
    Unchanged
    
    Basis Points(In thousands)RMBS
    
    $
    425,312
    
    
    $
    414,502
    
    
    $
    411,495Fair valueChange in fair value
    
    $
    10,810
    
    
    
    
    
    
    $
    (3,007
    )Change as a percent of fair value
    
    
    2.61
    %
    
    
    
    
    
    
    (0.73
    )%Interest Rate SwapsFair value
    
    $
    (12,296
    )
    
    $
    (7,697
    )
    
    $
    (1,971
    )Change in fair value
    
    $
    (4,599
    )
    
    
    
    
    
    $
    5,727Change as a percent of fair value
    
    
    59.75
    %
    
    
    
    
    
    
    74.70
    %Net Portfolio Impact
    
    $
    6,211
    
    
    
    
    
    
    $
    2,719
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Risk Management
  
    
    attempting to structure our borrowing agreements to have a range of different
maturities, terms, amortizations and interest rate adjustment periods;
    
    using interest rate derivatives including, swaps, caps, floors, mortgage
derivatives and forward sales, to adjust the interest rate sensitivity of our RMBS and
our borrowings; and
    
    actively managing, on an aggregate basis, the interest rate indices, interest
rate adjustment periods, and gross reset margins of our RMBS and the interest rate
indices and adjustment periods of our borrowings.
  
 ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of Effectiveness of Disclosure Controls and Procedures
  Change in Internal Control Over Financial Reporting
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Inherent Limitations on Effectiveness of Controls
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PART II. OTHER INFORMATION
 
 ITEM 1A. RISK FACTORS
 Part I  Item 1A. Risk Factors
 Loss of our Investment Company Act of 1940, as amended, or 1940 Act, exemption would adversely
affect us and reduce the market price of our shares and our ability to pay dividends.
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We expect our common stock to be delisted by the New York Stock Exchange, and we may be unable to
qualify for listing on an alternative exchange
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Uninsured losses or losses in excess of our insurance coverage could adversely affect our financial
condition and our cash flows, and we may also incur significantly increased costs and maintain
lower coverage in the future thereby increasing our risk of loss
    We are exposed to risk based on the concentration of the majority of our repurchase agreements with
a single counterparty.
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Our ability to use NOL carryovers and NCL carryovers to reduce future tax payments may be limited.
   The conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in
laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the federal
government, may adversely affect our business
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Current conditions in the credit markets have necessitated further workforce reductions, which may
harm our business.
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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ITEM 5. OTHER INFORMATION
 Cost Savings Initiative
    
 ITEM 6. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 (b) Documents filed as part of this Report:
 Exhibit No.
    
    Description of Exhibit3.1
    
    Articles of Amendment and Restatement of Deerfield Capital Corp., as amended and
supplemented.3.2
    
    Bylaws of Deerfield Capital Corp. (incorporated by reference to Exhibit 3.2 to
Deerfield Capital Corps quarterly report on Form 10-Q filed with the SEC on
August 11, 2008).10.1
    
    Letter Agreement by and among Taberna Preferred Funding III, Ltd., Taberna
Preferred Funding V, Ltd., Taberna Preferred Funding VII, Ltd., Taberna Preferred
Funding VIII, Ltd. and Taberna Preferred Funding IX, Ltd., on the one hand, and
Deerfield Capital LLC and Deerfield Capital Corp., on the other hand, dated as
November 7 2008.10.2
    
    Form of Transition Employment Agreement.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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SIGNATURES
  DEERFIELD CAPITAL CORP.(Registrant)Date: November 10, 2008
    
    By: /s/ JONATHAN W. TRUTTERJonathan W. Trutter, Chief Executive Officer(Principal Executive Officer)Date: November 10, 2008
    
    By: /s/ FRANCIS P. STRAUB IIIFrancis P. Straub III, Senior Vice President,Chief Financial Officer and Treasurer(Principal Financial and Accounting Officer)
 105