##### Table of Contents



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 June 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. Employer
Identification 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 JUNE 30, 2008
INDEX
 PagePart I.
    
    Financial InformationItem 1.
    
    Condensed Consolidated Financial Statements and Notes (Unaudited)Condensed Consolidated Balance Sheets - June 30, 2008 and December 31, 2007
    
    
    4Condensed Consolidated Statements of Operations - Three and Six Months Ended June 30, 2008 and 2007
    
    
    5Condensed Consolidated Statement of Stockholders Equity - Six Months Ended June 30, 2008
    
    
    6Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2008 and 2007
    
    
    7Notes to Condensed Consolidated Financial Statements
    
    
    9Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    33Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    70Item 4.
    
    Controls and Procedures
    
    
    73Part II.
    
    Other InformationItem 1A.
    
    Risk Factors
    
    
    74Item 6.
    
    Exhibits
    
    
    75Signatures
    
    
    
    
    76EX-3.1 CERTIFICATE OF CORRECTIONEX-3.2 BYLAWS OF DEERFIELD CAPITAL CORP.EX-10.1 LETTER AGREEMENTEX-10.2 AMENDED AND RESTATED FORBEARANCE AGREEMENTEX-31.1 SECTION 302 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICEREX-31.2 SECTION 302 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICEREX-32.1 SECTION 906 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
  2




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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
   Relating to our business generally:
 
    
    our current noncompliance with one of the continued listing standards of the New York
Stock Exchange (the NYSE) and the potential that we may be unable to timely restore our
compliance with that listing standard or to meet other NYSE listing standards, with the
result that our common stock may be suspended or delisted and we may be unable to obtain
an alternative listing for our common stock.
    
    actual financial results may be 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;
    
    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 real estate
investment trust (REIT) qualification or our current or any alternative exemption from
registration under the Investment Company Act of 1940, as amended (the 1940 Act);
    
    failure to comply with covenants contained in the agreements governing our
indebtedness;
    
    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;
    
    changes in the general economy or debt markets in which we invest;
    
    increases in borrowing costs relative to interest received on assets;
    
    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 attractive 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;
    
    adverse changes in accounting principles, tax law, or legal/regulatory requirements;
    
    changes in REIT qualification requirements, making it difficult for us to conduct our
investment strategy, and failure to maintain our qualification as a REIT;
    
    failure to comply with applicable laws and regulations or to maintain our exemption
from registration under the 1940 Act;
    
    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; and
    
    actions of domestic and foreign governments and the effect of war or terrorist
activity.
 Relating to the Investment Management segment:
 
    
    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 redemption of investment fund
investments by investors therein or 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;
    
    the reduction in CDO management fees or AUM resulting from payment defaults by issuers
of the underlying collateral, downgrades of the underling collateral 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;
    
    our dependence on third party distribution channels to market CDOs;
    
    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 its 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 the 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 its 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.
 Relating to the Merger:
 
    
    DFRs ability to integrate the businesses of DFR and DCM successfully and the amount of
time and expense to be spent and incurred in connection with the integration;
    
    the ability to realize the economic benefits that DFR anticipates as a result of its
acquisition of Deerfield & Company LLC (the Merger);
    
    failure to uncover all risks and liabilities associated with acquiring DCM;
    
    federal income tax liability as a result of owning DCM through taxable REIT
subsidiaries (TRSs) and the effect of DFRs acquisition of DCM on DFRs ability to
continue to qualify as a REIT;
    
    the impact of owning DCM on DFRs ability to rely on an exemption from registration
under the 1940 Act;
    
    the limitations or restrictions imposed on DCMs investment management services as a
result of DFRs ownership of DCM;
    
    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; and
    
    the impact of owning DCM on DFRs ability to implement certain alternative
organizational structures.
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##### Table of Contents



Part I. FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 June 30,
    
    
    December 31,2008
    
    
    2007(In thousands, except shareand per share amounts)ASSETSCash and cash equivalents
    
    $
    44,532
    
    
    $
    113,733Due from broker
    
    
    20,716
    
    
    
    270,630Restricted cash and cash equivalents
    
    
    68,462
    
    
    
    47,125Available-for-sale securities, including zero and $4,884,023 pledgedat fair value
    
    
    7,403
    
    
    
    4,897,972Trading securities, including $1,434,493 and $733,782 pledgedat fair value
    
    
    1,445,802
    
    
    
    1,444,505Other investments
    
    
    5,472
    
    
    
    5,472Derivative assets
    
    
    1,780
    
    
    
    4,537Loans held for sale
    
    
    264,559
    
    
    
    267,335Loans
    
    
    383,663
    
    
    
    466,360Allowance for loan losses
    
    
    (7,883
    )
    
    
    (5,300
    )Loans, net of allowance for loan losses
    
    
    375,780
    
    
    
    461,060Investment advisory fee receivables
    
    
    5,142
    
    
    
    6,409Interest receivable
    
    
    8,061
    
    
    
    39,216Other receivable
    
    
    985
    
    
    
    22,912Prepaid and other assets
    
    
    13,992
    
    
    
    14,721Deferred tax asset, net
    
    
    13,422
    
    
    
    Fixed assets, net
    
    
    9,793
    
    
    
    10,447Intangible assets, net
    
    
    70,642
    
    
    
    83,225Goodwill
    
    
    78,158
    
    
    
    98,670TOTAL ASSETS
    
    $
    2,434,701
    
    
    $
    7,787,969LIABILITIESRepurchase agreements, including $915 and $20,528 of accrued interest
    
    $
    1,408,955
    
    
    $
    5,303,865Due to broker
    
    
    5,649
    
    
    
    879,215Dividends payable
    
    
    1,667
    
    
    
    21,944Derivative liabilities
    
    
    6,796
    
    
    
    156,813Interest payable
    
    
    5,029
    
    
    
    28,683Accrued and other liabilities
    
    
    25,751
    
    
    
    35,652Short term debt
    
    
    483
    
    
    
    1,693Long term debt
    
    
    755,541
    
    
    
    775,368TOTAL LIABILITIES
    
    
    2,209,871
    
    
    
    7,203,233Series A cumulative convertible preferred stock; $0.001 par value, zero shares and
14,999,992
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; 66,758,356 and 51,752,720 shares issued and
66,693,418 and 51,655,317 shares outstanding
    
    
    67
    
    
    
    51Additional paid-in capital
    
    
    866,200
    
    
    
    748,216Accumulated other comprehensive loss
    
    
    (2,523
    )
    
    
    (83,783
    )Accumulated deficit
    
    
    (638,914
    )
    
    
    (195,910
    )TOTAL STOCKHOLDERS EQUITY
    
    
    224,830
    
    
    
    468,574TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    2,434,701
    
    
    $
    7,787,969
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three months ended June 30,
    
    
    Six months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands, except share and per share amounts)RevenuesInterest income
    
    $
    21,824
    
    
    $
    129,712
    
    
    $
    83,174
    
    
    $
    252,411Interest expense
    
    
    12,421
    
    
    
    102,539
    
    
    
    60,021
    
    
    
    201,398Net interest income
    
    
    9,403
    
    
    
    27,173
    
    
    
    23,153
    
    
    
    51,013Provision for loan losses
    
    
    2,302
    
    
    
    5,133
    
    
    
    4,502
    
    
    
    6,933Net interest income after provision for loan losses
    
    
    7,101
    
    
    
    22,040
    
    
    
    18,651
    
    
    
    44,080Investment advisory fees
    
    
    12,359
    
    
    
    
    
    
    
    24,478
    
    
    
    Total net revenues
    
    
    19,460
    
    
    
    22,040
    
    
    
    43,129
    
    
    
    44,080ExpensesManagement fee expense to related party
    
    
    
    
    
    
    3,430
    
    
    
    
    
    
    
    6,760Incentive fee expense to related party
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,185Compensation and benefits
    
    
    7,705
    
    
    
    
    
    
    
    17,063
    
    
    
    Depreciation and amortization
    
    
    2,580
    
    
    
    
    
    
    
    5,267
    
    
    
    Professional services
    
    
    2,343
    
    
    
    800
    
    
    
    3,730
    
    
    
    1,417Insurance expense
    
    
    733
    
    
    
    205
    
    
    
    1,467
    
    
    
    341Other general and administrative expenses
    
    
    2,459
    
    
    
    791
    
    
    
    4,510
    
    
    
    1,160Impairment of intangible assets and goodwill
    
    
    1,128
    
    
    
    
    
    
    
    29,034
    
    
    
    Total expenses
    
    
    16,948
    
    
    
    5,226
    
    
    
    61,071
    
    
    
    11,863Other Income and Gain (Loss)Net gain (loss) on available-for-sale securities
    
    
    (3,856
    )
    
    
    (243
    )
    
    
    (3,856
    )
    
    
    2,306Net loss on trading securities
    
    
    (1,747
    )
    
    
    (5,688
    )
    
    
    (202,466
    )
    
    
    (3,048
    )Net gain (loss) on loans and loans held for sale
    
    
    5,505
    
    
    
    (1,492
    )
    
    
    (21,037
    )
    
    
    470Net gain (loss) on derivatives
    
    
    6,070
    
    
    
    5,327
    
    
    
    (217,145
    )
    
    
    5,373Dividend income and other net gain (loss)
    
    
    76
    
    
    
    (361
    )
    
    
    194
    
    
    
    (97
    )Net other income and gain (loss)
    
    
    6,048
    
    
    
    (2,457
    )
    
    
    (444,310
    )
    
    
    5,004Income (loss) before income tax expense (benefit)
    
    
    8,560
    
    
    
    14,357
    
    
    
    (462,252
    )
    
    
    37,221Income tax expense (benefit)
    
    
    2,868
    
    
    
    (137
    )
    
    
    (4,334
    )
    
    
    200Net income (loss)
    
    $
    5,692
    
    
    $
    14,494
    
    
    $
    (457,918
    )
    
    $
    37,021NET INCOME (LOSS) PER SHARE  BASIC
    
    $
    0.08
    
    
    $
    0.28
    
    
    $
    (7.37
    )
    
    $
    0.72NET INCOME (LOSS) PER SHARE  DILUTED
    
    $
    0.08
    
    
    $
    0.28
    
    
    $
    (7.37
    )
    
    $
    0.72WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING  BASIC
    
    
    68,817,149
    
    
    
    51,596,928
    
    
    
    62,133,178
    
    
    
    51,592,137WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING  DILUTED
    
    
    68,817,149
    
    
    
    51,759,376
    
    
    
    62,133,178
    
    
    
    51,760,265
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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
    
    
    51,655
    
    
    $
    51
    
    
    $
    748,216
    
    
    $
    (83,783
    )
    
    $
    (195,910
    )
    
    $
    468,574Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (457,918
    )
    
    
    (457,918
    )
    
    $
    (457,918
    )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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (812
    )
    
    
    
    
    
    
    (812
    )
    
    
    (812
    )Previously designated derivatives  amortization
of net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    96,964
    
    
    
    
    
    
    
    96,964
    
    
    
    96,964Foreign currency translation gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22
    
    
    
    
    
    
    
    22
    
    
    
    22Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (361,744
    )Conversion of Series A cumulative convertible
preferred stock
into common stock
    
    
    15,000
    
    
    
    15
    
    
    
    117,150
    
    
    
    
    
    
    
    
    
    
    
    117,165Share-based compensation
    
    
    38
    
    
    
    1
    
    
    
    3,227
    
    
    
    
    
    
    
    
    
    
    
    3,228Preferred stock dividend and accretion
    
    
    
    
    
    
    
    
    
    
    (2,393
    )
    
    
    
    
    
    
    
    
    
    
    (2,393
    )Balance  June 30, 2008
    
    
    66,693
    
    
    $
    67
    
    
    $
    866,200
    
    
    $
    (2,523
    )
    
    $
    (638,914
    )
    
    $
    224,830
  6




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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Six months ended June 30,2008
    
    
    2007(In thousands)CASH FLOWS FROM OPERATING ACTIVITIES:Net (loss) income
    
    $
    (457,918
    )
    
    $
    37,021Adjustments to reconcile net (loss) income to net cash used in operating activities:Net premium and discount amortization on investments, loans and debt issuance
    
    
    1,243
    
    
    
    14,386Share-based compensation
    
    
    437
    
    
    
    671Hedge ineffectiveness
    
    
    
    
    
    
    (284
    )Net purchase of trading securities
    
    
    (341,845
    )
    
    
    (97,703
    )Net loss from trading securities
    
    
    202,466
    
    
    
    3,048Other-than-temporary impairment on available-for-sale securities
    
    
    3,856
    
    
    
    202Net loss on other investments
    
    
    
    
    
    
    250Net (purchases) proceeds on loans held for sale
    
    
    (7,398
    )
    
    
    12,545Net loss (gain) on loans and loans held for sale
    
    
    21,050
    
    
    
    (411
    )Provision for loan losses
    
    
    4,502
    
    
    
    6,933Net realized gain on available-for-sale securities
    
    
    
    
    
    
    (2,508
    )Net changes in undesignated derivatives
    
    
    (159,938
    )
    
    
    (499
    )Amortization of net loss (gain) on previously designated derivatives
    
    
    96,965
    
    
    
    (10,080
    )Net cash paid on terminated designated derivatives
    
    
    
    
    
    
    (3,791
    )Depreciation and amortization
    
    
    5,267
    
    
    
    Impairment of intangible assets and goodwill
    
    
    29,034
    
    
    
    Non-cash rental expense
    
    
    100
    
    
    
    Deferred tax benefit
    
    
    (12,905
    )
    
    
    Changes in operating assets and liabilities:Due from broker
    
    
    93,579
    
    
    
    10,418Interest receivable
    
    
    26,808
    
    
    
    (2,005
    )Other receivable
    
    
    1,268
    
    
    
    585Prepaid and other assets
    
    
    (687
    )
    
    
    (392
    )Accrued interest on repurchase agreements
    
    
    (19,613
    )
    
    
    (2,185
    )Due to broker
    
    
    1,836
    
    
    
    1,838Interest payable
    
    
    (8,667
    )
    
    
    6,943Management and incentive fee payable to related party
    
    
    
    
    
    
    10Accrued and other liabilities
    
    
    (7,169
    )
    
    
    (1,639
    )Net cash used in operating activities
    
    
    (527,729
    )
    
    
    (26,647
    )CASH FLOWS FROM INVESTING ACTIVITIES:Change in restricted cash and cash equivalents
    
    
    (21,337
    )
    
    
    (32,517
    )Purchase of available-for-sale securities
    
    
    (1,750
    )
    
    
    (1,778,615
    )Proceeds from the sale of available-for-sale securities
    
    
    
    
    
    
    1,157,721Principal payments on available-for-sale securities
    
    
    22,824
    
    
    
    730,049Proceeds 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
    
    
    170,387
    
    
    
    Origination and purchase of loans
    
    
    (7,070
    )
    
    
    (173,071
    )Principal payments on loans
    
    
    47,878
    
    
    
    94,687Proceeds from sale of loans
    
    
    26,368
    
    
    
    3,166Proceeds from sale of loans held for sale previously classified as held for investment
    
    
    1,864
    
    
    
    Purchase of other investments
    
    
    
    
    
    
    (550
    )Net purchases of fixed assets
    
    
    (9
    )
    
    
    Net cash provided by investing activities
    
    
    4,377,353
    
    
    
    870CASH FLOWS FROM FINANCING ACTIVITIES:Net payments under repurchase agreements
    
    
    (3,875,296
    )
    
    
    (21,357
    )Payments made on long term debt
    
    
    
    
    
    
    (261
    )Proceeds from Wachovia Facility
    
    
    3,000
    
    
    
    62,600Payments made on Wachovia Facility
    
    
    (23,022
    )
    
    
    (5,600
    )Payment of debt issuance costs
    
    
    (533
    )
    
    
    (3,478
    )Payments on designated derivative containing a financing element
    
    
    
    
    
    
    (26
    )Dividends paid
    
    
    (21,736
    )
    
    
    (43,446
    )Payments made on short term debt
    
    
    (1,225
    )
    
    
    Net cash used in financing activities
    
    
    (3,918,812
    )
    
    
    (11,568
    )Foreign currency translation
    
    
    (13
    )
    
    
    Net decrease in cash and cash equivalents
    
    
    (69,201
    )
    
    
    (37,345
    )Cash and cash equivalents at beginning of period
    
    
    113,733
    
    
    
    72,523Cash and cash equivalents at end of period
    
    $
    44,532
    
    
    $
    35,178
 7




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##### Table of Contents



DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (Continued)
 Six months ended June 30,2008
    
    
    2007(In thousands)SUPPLEMENTAL DISCLOSURE:Cash paid for interest
    
    $
    96,866
    
    
    $
    227,247Cash paid for income tax
    
    
    3,974
    
    
    
    NONCASH INVESTING AND FINANCING ACTIVITIES:Unsettled held for investment loan sales  due from broker
    
    $
    
    
    
    $
    9,000Unsettled
loans held for sale sales; previously  held for investment  due to broker
    
    
    3,301
    
    
    
    Net settlement of interest expense from derivatives
    
    
    
    
    
    
    3,429Settlement of interest income as an addition to principal balance of loans and loans held
for sale
    
    
    3,211
    
    
    
    3,069Receipt of warrants
    
    
    1,092
    
    
    
    214Principal payments receivable from available-for-sale securities
    
    
    976
    
    
    
    21,362Principal payments receivable from bank loans held for investment
    
    
    
    
    
    
    232Issuance of stock for payment of prior year incentive fee
    
    
    
    
    
    
    3Share-based compensation
    
    
    2,789
    
    
    
    Series A cumulative convertible preferred stock dividend and accretion
    
    
    2,393
    
    
    
    Merger purchase price adjustments
    
    
    561
    
    
    
    
  8




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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
     9




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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
 10




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##### Table of Contents



Fair Value Measurements and Presentation
 .
 Level 1
  Level 2
  Level 3
       11




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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
 Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities Earnings per Share
 12




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##### Table of Contents



3. MERGER WITH DEERFIELD
  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 June 30, 2007
    
    Six months ended June 30, 2007(In thousands, except per share data)Total net revenues
    
    $
    33,795
    
    
    $
    64,786Income before income tax expense
    
    $
    12,780
    
    
    $
    34,177Net income
    
    $
    13,049
    
    
    $
    35,000Net income attributable to common stockholders
    
    $
    6,895
    
    
    $
    22,690Net income per share  basic
    
    $
    0.13
    
    
    $
    0.44Net income per share  diluted
    
    $
    0.10
    
    
    $
    0.34
  4. FAIR VALUE OF FINANCIAL INSTRUMENTS
  13




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##### Table of Contents



Available-for-sale securities
  Trading securities
    Derivative assets and liabilities
  Loans held for sale
  Assets and liabilities measured at fair value on a recurring basis
  CarryingLevel 1
    
    
    Level 2
    
    
    Level 3
    
    
    Value(In thousands)Available-for-sale securities
    
    $
    
    
    
    $
    
    
    
    $
    7,403
    
    
    $
    7,403Trading securities
    
    
    
    
    
    
    1,415,290
    
    
    
    30,512
    
    
    
    1,445,802Derivative assets
    
    
    
    
    
    
    184
    
    
    
    1,596
    
    
    
    1,780Total financial instrument assets
    
    $
    
    
    
    $
    1,415,474
    
    
    $
    39,511
    
    
    $
    1,454,985Derivative liabilities
    
    $
    
    
    
    $
    6,150
    
    
    $
    646
    
    
    $
    6,796
 14




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##### Table of Contents



Changes in Level 3 recurring fair value measurements
   Changes in UnrealizedFair Value Measurements Using Significant Unobservable Inputs
    
    
    Gains/(Losses) Related toEstimated Fair Value
    
    
    Net Realized/Unrealized
    
    
    Purchases, Sales, Issuances
    
    
    Net Transfers In/(Out)
    
    
    Estimated Fair Value
    
    
    Financial Instruments HeldMarch 31, 2008
    
    
    Gains (Losses)
    
    
    and Settlements, Net
    
    
    of Level 3
    
    
    June 30, 2008
    
    
    at June 30, 2008(In thousands)Available-for-sale securities
    
    $
    9,935
    
    
    $
    (2,532
    ) (1)
    
    $
    
    
    
    $
    
    
    
    $
    7,403
    
    
    $
    (2,532
    ) (1)Trading securities
    
    
    32,539
    
    
    
    (1,328
    ) (2)
    
    
    (699
    )
    
    
    
    
    
    
    30,512
    
    
    
    (1,355
    ) (2)Derivative assets
    
    
    1,221
    
    
    
    375
    (3)
    
    
    
    
    
    
    
    
    
    
    1,596
    
    
    
    375
    (3)Total financial
instrument assets
    
    $
    43,695
    
    
    $
    (3,485
    )
    
    $
    (699
    )
    
    $
    
    
    
    $
    39,511
    
    
    $
    (3,512
    )Derivative liabilities
    
    $
    1,912
    
    
    $
    (1,618
    ) (3)
    
    $
    352
    
    
    $
    
    
    
    $
    646
    
    
    $
    (1,266
    ) (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. Impairments on available-for-sale securities are
reported within net gain (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 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 gain (loss) on derivatives in the condensed consolidated
statements of operations.  Changes in UnrealizedFair Value Measurements Using Significant Unobservable Inputs
    
    
    Gains/(Losses) Related toEstimated Fair Value
    
    
    Net Realized/Unrealized
    
    
    Purchases, Sales, Issuances
    
    
    Net Transfers Out
    
    
    Estimated Fair Value
    
    
    Financial Instruments HeldJanuary 1, 2008
    
    
    Losses
    
    
    and Settlements, Net
    
    
    of Level 3
    
    
    June 30, 2008
    
    
    at June 30, 2008(In thousands)Available-for-sale securities
    
    $
    10,268
    
    
    $
    (4,615
    ) (1)
    
    $
    1,750
    
    
    $
    
    
    
    $
    7,403
    
    
    $
    (4,641
    ) (1)Trading securities
    
    
    1,894,429
    
    
    
    (189,442
    ) (2)
    
    
    (1,644,739
    )
    
    
    (29,736
    ) (4)
    
    
    30,512
    
    
    
    (14,839
    ) (2)Derivative assets
    
    
    318
    
    
    
    (829
    ) (3)
    
    
    2,107
    
    
    
    
    
    
    
    1,596
    
    
    
    479
    (3)Total financial
instrument assets
    
    $
    1,905,015
    
    
    $
    (194,886
    )
    
    $
    (1,640,882
    )
    
    $
    (29,736
    )
    
    $
    39,511
    
    
    $
    (19,001
    )Derivative liabilities
    
    $
    1,493
    
    
    $
    (2,306
    ) (3)
    
    $
    1,459
    
    
    $
    
    
    
    $
    646
    
    
    $
    (1,817)
    (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. Impairments on available-for-sale securities are
reported within net gain (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 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 gain (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 June 30, 2008. 15




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##### Table of Contents



Assets measured at fair value on a nonrecurring basis
  CarryingLevel 1
    
    
    Level 2
    
    
    Level 3
    
    
    Value(In thousands)Loans held for sale
    
    $
    
    
    
    $
    
    
    
    $
    236,471
    
    
    $
    236,471Loans
    
    
    
    
    
    
    
    
    
    
    2,677
    
    
    
    2,677Intangible assets, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1)Total assets at fair value on a nonrecurring basis
    
    $
    
    
    
    $
    
    
    
    $
    239,148
    
    
    $
    239,148
 
 (1)
    
    One intangible asset identified as a result of the Merger was impaired and marked to
fair value of zero as of June 30, 2008. See Note 11 for further information.   Three months ended
    
    
    Six months endedJune 30, 2008
    
    
    June 30, 2008(In thousands)Loans held for sale
    
    $
    2,646
    
    (1)
    $
    (21,878
    )Loans
    
    
    (383
    )
    (2)
    
    (383
    )Intangible assets, net
    
    
    (1,004
    )
    (3)
    
    (1,004
    )Total nonrecurring fair value gains (losses)
    
    $
    1,259
    
    
    $
    (20,491
    )
 
 (1)
    
    Changes in the fair value on loans held for sale are reported within net gain (loss) on
loans and loans held for sale in the condensed consolidated statements
of operations.(2)
    
    Impairment charges to record loans to fair value are reported within provision for loan
losses in the condensed consolidated statements of operations.(3)
    
    Impairment charges to intangible assets are reported within impairment of intangible
assets and goodwill in the condensed consolidated statements of operations. Disclosure About Fair Value of Financial Instruments,
 16




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##### Table of Contents



EstimatedCarrying
    
    FairValue
    
    Value(In thousands)Financial assets:Cash and cash equivalents (1)
    
    $
    44,532
    
    
    $
    44,532Restricted cash and cash equivalents (1)
    
    
    68,462
    
    
    
    68,462Available-for-sale securities (2)
    
    
    7,403
    
    
    
    7,403Trading securities (2)
    
    
    1,445,802
    
    
    
    1,445,802Other investments (3)
    
    
    5,472
    
    
    
    5,472Derivative assets (2)
    
    
    1,780
    
    
    
    1,780Loans held for sale (2)
    
    
    264,559
    
    
    
    265,142Loans, net of allowance for loan losses (2) (3)
    
    
    375,780
    
    
    
    367,391Investment advisory fee receivables (1)
    
    
    5,142
    
    
    
    5,142Financial liabilities:Repurchase agreements (1)
    
    
    1,408,955
    
    
    
    1,408,955Derivative liabilities (2)
    
    
    6,796
    
    
    
    6,796Short term debt (1)
    
    
    483
    
    
    
    483Long term debt: (4)Wachovia Facility
    
    
    53,412
    
    
    
    53,412Market Square CLO
    
    
    276,000
    
    
    
    276,000DFR MM CLO
    
    
    231,000
    
    
    
    231,000Trust preferred securities
    
    
    123,717
    
    
    
    123,717Series A & Series B Notes (5)
    
    
    71,412
    
    
    
    71,412
 
 (1)
    
    The carrying amounts approximate the fair value due to the short term nature of these
instruments.(2)
    
    The estimated fair values were determined in accordance with SFAS No. 157 as described in
detail above.(3)
    
    It was not practicable to estimate the fair value of certain loans and other
investments because they are not traded in an active market, therefore, the carrying value
has been displayed as an approximation of fair value in absence of an available broker
quote. If an independent pricing service cannot provide fair value estimates for a given
loan, the Company may determine estimated fair value based on some or all of the following:
(a) current financial information of the borrowing company and performance against its
operating plan; (b) changes in the fair value of collateral supporting the loan;
(c) changes to the market
for the borrowing companys service or product and (d) present value of projected future cash
flows.(4)
    
    The carrying amount approximated fair value as the interest rate on all of the
Companys long term debt resets quarterly to short term market rates plus a fixed credit
spread.(5)
    
    See Note 15 for further information regarding the Series A and Series B Notes. 5. FAIR VALUE OPTION
  17




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##### Table of Contents



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
    
    $
    3,980
    
    
    $
    
    
    
    $
    (632
    )
    
    $
    3,348ABS held in Market Square CLO
    
    
    1,750
    
    
    
    
    
    
    
    
    
    
    
    1,750CMBS
    
    
    1,012
    
    
    
    
    
    
    
    
    
    
    
    1,012Other investments
    
    
    2,974
    
    
    
    
    
    
    
    (1,681
    )
    
    
    1,293Total
    
    $
    9,716
    
    
    $
    
    
    
    $
    (2,313
    )
    
    $
    7,403
   WeightedAmortized
    
    
    Estimated
    
    
    AverageWeighted Average Life
    
    Cost
    
    
    Fair Value
    
    
    Coupon(In thousands)Greater than one year and less than five years
    
    $
    2,974
    
    
    $
    1,293
    
    
    
    5.19
    %Greater than five years and less than ten years
    
    
    6,742
    
    
    
    6,110
    
    
    
    6.60
    %Total
    
    $
    9,716
    
    
    $
    7,403
    
    
    
    6.37
    %
  18




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##### Table of Contents



Less than 12 Months
    
    
    More than 12 Months
    
    
    TotalNumber
    
    
    Estimated
    
    
    Gross
    
    
    Number
    
    
    Estimated
    
    
    Gross
    
    
    Number
    
    
    Estimated
    
    
    Grossof
    
    
    Fair
    
    
    Unrealized
    
    
    of
    
    
    Fair
    
    
    Unrealized
    
    
    of
    
    
    Fair
    
    
    UnrealizedSecurities
    
    
    Value
    
    
    Losses
    
    
    Securities
    
    
    Value
    
    
    Losses
    
    
    Securities
    
    
    Value
    
    
    Losses(Dollars in thousands)High-yield corporate bonds held in Market Square CLO
    
    
    4
    
    
    $
    3,348
    
    
    $
    (632
    )
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    4
    
    
    $
    3,348
    
    
    $
    (632
    )Other investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1,293
    
    
    
    (1,681
    )
    
    
    1
    
    
    
    1,293
    
    
    
    (1,681
    )Total temporarily impaired securities
    
    
    4
    
    
    $
    3,348
    
    
    $
    (632
    )
    
    
    1
    
    
    $
    1,293
    
    
    $
    (1,681
    )
    
    
    5
    
    
    $
    4,641
    
    
    $
    (2,313
    )
   
    
    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.
 Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets
   Three months ended June 30,
    
    
    Six months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands)Realized gains
    
    $
    
    
    
    $
    112
    
    
    $
    
    
    
    $
    4,679Realized losses
    
    
    
    
    
    
    (355
    )
    
    
    
    
    
    
    (2,171
    )Net realized gains (losses)
    
    
    
    
    
    
    (243
    )
    
    
    
    
    
    
    2,508Other-than-temporary
impairment
    
    
    (3,856
    )
    
    
    
    
    
    
    (3,856
    )
    
    
    (202
    )Net gain (loss)
    
    $
    (3,856
    )
    
    $
    (243
    )
    
    $
    (3,856
    )
    
    $
    2,306
  19




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##### Table of Contents



7. TRADING SECURITIES
  EstimatedSecurity Description
    
    Fair Value(In thousands)RMBS:Agency RMBS
    
    $
    415,336AAA-rated non-Agency RMBS
    
    
    28,849U. S. Treasury bills
    
    
    999,954Preferred shares of CDOs
    
    
    1,663Total
    
    $
    1,445,802
   Amortized
    
    
    Estimated
    
    
    WeightedCost
    
    
    Fair Value
    
    
    AverageWeighted Average Life
    

(In thousands)
    
    
    CouponLess than one year
    
    $
    999,915
    
    
    $
    999,954
    
    
    
    1.02
    %Greater than one year and less than five years
    
    
    28,345
    
    
    
    28,022
    
    
    
    5.52
    %Greater than five years and less than ten years
    
    
    390,430
    
    
    
    383,751
    
    
    
    5.21
    %Greater than ten years
    
    
    37,852
    
    
    
    34,075
    
    
    
    5.62
    %Total
    
    $
    1,456,542
    
    
    $
    1,445,802
    
    
    
    2.35
    %
    Three months ended June 30,
    
    
    Six months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands)Realized gains
    
    $
    788
    
    
    $
    285
    
    
    $
    44,324
    
    
    $
    398Realized losses
    
    
    (864
    )
    
    
    
    
    
    
    (213,466
    )
    
    
    (66
    )Net realized gains (losses)
    
    $
    (76
    )
    
    $
    285
    
    
    $
    (169,142
    )
    
    $
    332
 20




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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 Heldfor Sale (1)
    
    
    Loans
    
    
    TotalType of Loan
    

(In thousands)Loans held in Market Square CLO
    
    $
    257,939
    
    
    $
    
    
    
    $
    257,939Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    
    
    
    
    259,577
    
    
    
    259,577Loans held in Wachovia Facility
    
    
    4,484
    
    
    
    85,143
    
    
    
    89,627Other corporate leveraged loans
    
    
    
    
    
    
    24,879
    
    
    
    24,879Commercial real estate loans
    
    
    2,136
    
    
    
    14,064
    
    
    
    16,200$
    264,559
    
    
    
    383,663
    
    
    
    648,222Allowance for loan losses
    
    
    
    
    
    
    (7,883
    )
    
    
    (7,883
    )$
    375,780
    
    
    $
    640,339
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value.   21




---



##### Table of Contents



Allowance for Loan Losses2008
    
    
    2007(In thousands)Allowance for loan losses at January 1
    
    $
    5,300
    
    
    $
    2,000Provision for loan losses
    
    
    4,502
    
    
    
    6,933Charge-offs
    
    
    (600
    )
    
    
    Transfers to loans held for sale
    
    
    (1,319
    )
    
    
    Allowance for loan losses at June 30
    
    $
    7,883
    
    
    $
    8,933
    10. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
   Notional
    
    
    
    
    
    
    
    
    
    
    Estimated NetCount
    
    
    Amount
    
    
    Assets
    
    
    Liabilities
    
    
    Fair Value(In thousands)Interest rate swaps
    
    
    18
    
    
    $
    454,000
    
    
    $
    184
    
    
    $
    (6,043
    )
    
    $
    (5,859
    )Interest rate cap
    
    
    1
    
    
    
    40,000
    
    
    
    
    
    
    
    (107
    )
    
    
    (107
    )Credit default swaps  protection seller
    
    
    3
    
    
    
    11,000
    
    
    
    28
    
    
    
    (151
    )
    
    
    (123
    )Total return swaps
    
    
    2
    
    
    
    14,406
    
    
    
    63
    
    
    
    (495
    )
    
    
    (432
    )Warrants
    
    
    4
    
    
    
    n/a
    
    
    
    1,505
    
    
    
    
    
    
    
    1,50528
    
    
    $
    519,406
    
    
    $
    1,780
    
    
    $
    (6,796
    )
    
    $
    (5,016
    )
 
 n/a  not applicable 22




---



##### Table of Contents



Interest Rate Swaps
  ,
  Interest Rate Cap
  23




---



##### Table of Contents



Credit Default Swaps
  Total Return Swaps
  Warrants
  11. IMPAIRMENT OF INTANGIBLE ASSETS AND GOODWILL
   12. REPURCHASE AGREEMENTS
  24




---



##### Table of Contents



Overnight
    
    
    Between1 Day or
    
    
    2 and 30Less
    
    
    Days
    
    
    Total(In thousands)RMBS:Estimated fair value of securities pledged,
including accrued interest (1)
    
    $
    19,563
    
    
    $
    413,616
    
    
    $
    433,179Repurchase agreement liabilities associated
with these securities
    
    
    8,939
    
    
    
    399,818
    
    
    
    408,757Weighted average interest rate of
repurchase agreement liabilities
    
    
    3.51
    %
    
    
    2.51
    %
    
    
    2.53
    %U.S. Treasury bills:Estimated fair value of securities pledged,
including accrued interest
    
    $
    999,954
    
    
    $
    
    
    
    $
    999,954Repurchase agreement liabilities associated
with these securities
    
    
    1,000,198
    
    
    
    
    
    
    
    1,000,198Weighted average interest rate of
repurchase agreement liabilities
    
    
    0.63
    %
    
    
    
    
    
    
    0.63
    %Total:Estimated fair value of securities pledged,
including accrued interest (1)
    
    $
    1,019,517
    
    
    $
    413,616
    
    
    $
    1,433,133Repurchase agreement liabilities associated
with these securities
    
    
    1,009,137
    
    
    
    399,818
    
    
    
    1,408,955Weighted average interest rate of
repurchase agreement liabilities
    
    
    0.66
    %
    
    
    2.51
    %
    
    
    1.18
    %
 
 (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
    
    $
    1,875
    
    
    $
    717U.S. Treasury bills
    
    
    
    
    
    
    198$
    1,875
    
    
    $
    915
 25




---



##### Table of Contents



Weighted-AverageMaturity ofRepurchaseAmount at Risk (1)
    
    
    Agreements(In thousands)
    
    

(In days)Counterparties:Bank of America Securities LLC
    
    $
    6,530
    
    
    
    1Deutsche Bank Securities Inc.
    
    
    10,064
    
    
    
    8Fortis Securities LLC
    
    
    7,341
    
    
    
    1HSBC Securities (USA), Inc.
    
    
    2,347
    
    
    
    2Total
    
    $
    26,282
    
    
    
    1
 
 (1)
    
    Equal to the fair value of securities pledged (including net additional repurchase agreement
collateral pledged of $1.2 million), minus repurchase agreement liabilities
and related accrued interest payable.  13. SECURITIES RECEIVED AND PLEDGED AS COLLATERAL
   14. SHORT TERM DEBT
   26




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##### Table of Contents



15. LONG TERM DEBT
  Weighted
    
    
    Fair ValueCarrying
    
    
    Average
    
    
    of CollateralValue
    
    
    Rate
    
    
    (including accrued interest)(In thousands)Wachovia Facility
    
    $
    53,412
    
    
    
    4.79
    %
    
    $
    100,999Market Square CLO
    
    
    276,000
    
    
    
    3.31
    %
    
    
    277,979DFR MM CLO
    
    
    231,000
    
    
    
    3.40
    %
    
    
    309,757Trust preferred securities
    
    
    123,717
    
    
    
    5.67
    %
    
    
    n/aSeries A & Series B Notes
    
    
    71,412
    
    
    
    7.70
    %
    
    
    197,246
    (1)Total long term debt
    
    $
    755,541
    
    
    
    4.24
    %
    
    $
    885,981
 
 (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    27




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##### Table of Contents



16. STOCKHOLDERS EQUITY
   Performance shares as of December 31, 2007
    
    
    Granted
    
    
    2,314,673Forfeiture
    
    
    (228,141
    )Performance shares as of June 30, 2008
    
    
    2,086,532
   Non-vested as of December 31, 2007
    
    
    97,403Granted
    
    
    Vested
    
    
    (32,468
    )Forfeiture
    
    
    (649
    )Non-vested as of June 30, 2008
    
    
    64,286
 28




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##### Table of Contents



17. COMPUTATION OF EARNINGS PER SHARE
  Three months ended June 30,
    
    
    Six months ended June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands, except per share data)Net income (loss)
    
    $
    5,692
    
    
    $
    14,494
    
    
    $
    (457,918
    )
    
    $
    37,021Weighted average shares used in basic computation:Common Stock
    
    
    68,817
    
    
    
    51,597
    
    
    
    62,133
    
    
    
    51,592Dilutive effect of:Unvested restricted stock
    
    
    
    
    
    
    109
    
    
    
    
    
    
    
    101Unexercised options to purchase common stock
    
    
    
    
    
    
    53
    
    
    
    
    
    
    
    67Weighted average shares used in diluted computation
    
    
    68,817
    
    
    
    51,759
    
    
    
    62,133
    
    
    
    51,760Net income (loss) per share  basic
    
    $
    0.08
    
    
    $
    0.28
    
    
    $
    (7.37
    )
    
    $
    0.72Net income (loss) per share  diluted
    
    $
    0.08
    
    
    $
    0.28
    
    
    $
    (7.37
    )
    
    $
    0.72
  18. ACCUMULATED OTHER COMPREHENSIVE LOSS
  For the six months ended June 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
    )Unrealized net loss for the period
    
    
    (812
    )
    
    
    
    
    
    
    
    
    
    
    (812
    )Cumulative effect adjustment from the
adoption of SFAS No. 159
    
    
    (14,914
    )
    
    
    
    
    
    
    
    
    
    
    (14,914
    )Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    22
    
    
    
    22Reclassification adjustments:Accelerated amortization (1)
    
    
    
    
    
    
    91,651
    
    
    
    
    
    
    
    91,651Hedging amortization recognized in
earnings
    
    
    
    
    
    
    5,313
    
    
    
    
    
    
    
    5,313Ending balance  June 30, 2008
    
    $
    (2,313
    )
    
    $
    (275
    )
    
    $
    65
    
    
    $
    (2,523
    )
 
 (1)
    
    Due to the repayments of repurchase agreement obligations during the six months ended
June 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. 19. INCOME TAXES
  29




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20. SEGMENT REPORTING
  30




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##### Table of Contents



For the three months ended June 30, 2008(In thousands)Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    ConsolidatedInterest income
    
    $
    155
    
    
    $
    21,669
    
    
    $
    
    
    
    $
    21,824Interest expense
    
    
    1,583
    
    
    
    10,838
    
    
    
    
    
    
    
    12,421Net interest income (expense)
    
    
    (1,428
    )
    
    
    10,831
    
    
    
    
    
    
    
    9,403Provision for loan losses
    
    
    
    
    
    
    2,302
    
    
    
    
    
    
    
    2,302Net interest income after
provision for loan losses
    
    
    (1,428
    )
    
    
    8,529
    
    
    
    
    
    
    
    7,101Investment advisory fees
    
    
    16,783
    
    
    
    
    
    
    
    (4,424
    )
    
    
    12,359Total net revenues
    
    $
    15,355
    
    
    $
    8,529
    
    
    $
    (4,424
    ) (1)
    
    $
    19,460Net income
    
    $
    728
    
    
    $
    4,964
    
    
    $
    
    
    
    $
    5,692Depreciation and amortization
    
    $
    2,580
    
    
    $
    
    
    
    $
    
    
    
    $
    2,580Income tax expense
    
    $
    479
    
    
    $
    2,389
    
    
    $
    
    
    
    $
    2,868
 For the six months ended June 30, 2008(In thousands)Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    ConsolidatedInterest income
    
    $
    497
    
    
    $
    82,677
    
    
    $
    
    
    
    $
    83,174Interest expense
    
    
    3,554
    
    
    
    56,467
    
    
    
    
    
    
    
    60,021Net interest income (expense)
    
    
    (3,057
    )
    
    
    26,210
    
    
    
    
    
    
    
    23,153Provision for loan losses
    
    
    
    
    
    
    4,502
    
    
    
    
    
    
    
    4,502Net interest income after
provision for loan losses
    
    
    (3,057
    )
    
    
    21,708
    
    
    
    
    
    
    
    18,651Investment advisory fees
    
    
    32,860
    
    
    
    
    
    
    
    (8,382
    )
    
    
    24,478Total net revenues
    
    $
    29,803
    
    
    $
    21,708
    
    
    $
    (8,382
    ) (1)
    
    $
    43,129Net loss
    
    $
    (20,046
    )
    
    $
    (437,872
    )
    
    $
    
    
    
    $
    (457,918
    )Depreciation and amortization
    
    $
    5,267
    
    
    $
    
    
    
    $
    
    
    
    $
    5,267Income tax expense (benefit)
    
    $
    (8,191
    )
    
    $
    3,857
    
    
    $
    
    
    
    $
    (4,334
    )As of June 30, 2008(In thousands)Identifiable assets
    
    $
    197,246
    
    
    $
    2,239,542
    
    
    $
    (2,087
    ) (2)
    
    $
    2,434,701
 
 (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
   31




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##### Table of Contents



NYSE
Continued Listing Standard
  Other Commitments
  22. SUBSEQUENT EVENTS
      32




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##### Table of Contents



ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Part I  Item 1A. Risk Factors. Part I   Item 1.
Financial Statements
 General
  Overview
 First Quarter Overview
   First Quarter Overview
  33




---



##### Table of Contents




    
    Agency RMBS with an amortized cost of $4.6 billion were sold at a net realized gain of $24.4 million.
    
    AAA-rated 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
   Investment Management Segment
    34




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##### Table of Contents



AUM
  Number of
    
    
    AUM as ofAccounts
    
    
    July 1, 2008 (1)(In thousands)CDOs (2)Bank loans (3)
    
    
    15
    
    
    $
    5,151,278Asset-backed securities
    
    
    13
    
    
    
    6,336,532Investment grade credit
    
    
    2
    
    
    
    620,883Total CDOs
    
    
    
    
    
    
    12,108,693Investment Fund (4)Fixed income arbitrage
    
    
    1
    
    
    
    436,156Separately managed accounts (5)
    
    
    6
    
    
    
    431,480Total AUM (6)
    
    
    
    
    
    $
    12,976,329
 
 (1)
    
    AUM numbers are reported as of July 1, 2008, rather than as of June 30, 2008, to be
inclusive of investment fund contributions, if any, effective on the first of the month.(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 July 1, 2008. Our CDOs/Bank loans AUM includes AUM
related to our structured loan fund.(3)
    
    The AUM for our Euro-denominated CDO has been converted into U.S. dollars using the spot rate
of exchange on June 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.(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 $295.3 million and $300.8 million related to Market Square CLO and
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 DC LLC or an affiliate thereof. All
other amounts included in the Principal Investing portfolio are excluded from Total AUM. Principal Investing Segment
  35




---



##### Table of Contents



June 30, 2008Carrying
    
    
    % of TotalPrincipal Investments
    
    Value
    
    
    Investments(In thousands)Real Estate Investments:RMBS (1)
    
    $
    444,185
    
    
    
    21.1
    %Commercial real estate loans and securities
    
    
    17,212
    
    
    
    0.8
    %461,397
    
    
    
    21.9
    %Government Investments:U.S. Treasury bills
    
    
    999,954
    
    
    
    47.5
    %Corporate Investments:Corporate leverage loans:Loans held in DFR MM CLO
    
    
    259,577
    
    
    
    12.3
    %Loans held in Wachovia Facility
    
    
    89,627
    
    
    
    4.2
    %Other corporate leveraged loans (2)
    
    
    24,879
    
    
    
    1.2
    %Assets held in Market Square CLO (3)
    
    
    263,037
    
    
    
    12.5
    %Equity securities
    
    
    5,472
    
    
    
    0.3
    %Other investments
    
    
    1,293
    
    
    
    0.1
    %643,885
    
    
    
    30.6
    %Total Investments
    
    
    2,105,236
    
    
    
    100.0
    %Allowance for loan losses
    
    
    (7,883
    )Net Investments
    
    $
    2,097,353
 
 (1)
    
    RMBS are either Agency RMBS or AAA-rated non-Agency RMBS.(2)
    
    Other corporate leveraged loans excludes credit default and total return swaps.(3)
    
    Includes syndicated bank loans of $257.9 million, high yield corporate bonds of
$3.3 million and ABS of $1.8 million as of June 30, 2008. Trends
  Liquidity.
  36




---



##### Table of Contents



Corporate credit performance.
 Credit spreads.
 CDO financing and management.
   Interest rate environment.
 Shape of the yield curve
 37




---



##### Table of Contents



Valuation of investments.
 Prepayment rates.
 Investor demand.
 Reliance on agency ratings.
 Critical Accounting Policies
  Fair Value of Financial Instruments
 Fair Value Measurements, .
 Level 1
  38




---



##### Table of Contents



Level 2
  Level 3
         39




---



##### 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
    40




---



##### Table of Contents



Derivative assets and liabilities
  Loans Held for Sale
  Fair Value Option
 The Fair Value Option for Financial Assets
and Liabilities,
  Interest Income Recognition
 Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases.
  41




---



##### Table of Contents



Investment Advisory Fees
 Accounting for Management Fees Based on a Formula
  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
 42




---



##### Table of Contents



Variable Interest Entities
 Consolidation of Variable Interest Entities
 Income Taxes
      43




---



##### Table of Contents



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
 Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating Securities, Earnings per Share
 44




---



##### Table of Contents



Financial Condition
  Carrying ValueAvailable-for-
    
    
    Trading
    
    
    Other
    
    
    Loans HeldSecurity Description
    
    Sale Securities
    
    
    Securities
    
    
    Investments
    
    
    For Sale
    
    
    Loans
    
    
    Total(In thousands)RMBS (Agency/AAA-rated non-Agency)
    
    $
    
    
    
    $
    444,185
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    444,185U.S. Treasury bills
    
    
    
    
    
    
    999,954
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    999,954Corporate leveraged loans (1):Loans held in DFR MM CLO
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    259,577
    
    
    
    259,577Loans held in Wachovia Facility
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,484
    
    
    
    85,143
    
    
    
    89,627Other corporate leveraged loans (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,879
    
    
    
    24,879Commercial
mortgage-backed assets (3)
    
    
    1,012
    
    
    
    
    
    
    
    
    
    
    
    2,136
    
    
    
    14,064
    
    
    
    17,212Equity securities
    
    
    
    
    
    
    
    
    
    
    5,472
    
    
    
    
    
    
    
    
    
    
    
    5,472Total structured and syndicated assets
    
    
    1,012
    
    
    
    
    
    
    
    5,472
    
    
    
    6,620
    
    
    
    383,663
    
    
    
    396,767Assets held
in Market Square CLO (4)
    
    
    5,098
    
    
    
    
    
    
    
    
    
    
    
    257,939
    
    
    
    
    
    
    
    263,037Other
investments and loans (5)
    
    
    1,293
    
    
    
    1,663
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,956Total alternative assets
    
    
    7,403
    
    
    
    1,663
    
    
    
    5,472
    
    
    
    264,559
    
    
    
    383,663
    
    
    
    662,760Total invested assets
    
    $
    7,403
    
    
    $
    1,445,802
    
    
    $
    5,472
    
    
    $
    264,559
    
    
    
    383,663
    
    
    $
    2,106,899Allowance for loan losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,883
    )$
    375,780
 
 (1)
    
    Corporate leveraged loans exclude CDS with an estimated net negative fair value of $0.1
million and a $11.0 million gross notional value. Also excluded are total return swaps with
an estimated net negative fair value of $0.4 million and a $14.4 million notional value.(2)
    
    This amount is reported gross of the $7.5 million allowance for loan losses.(3)
    
    Commercial mortgage-backed assets classified as Loans are
reported gross of the $0.4 million allowance for loan losses.(4)
    
    Includes syndicated bank loans of $257.9 million, high yield corporate bonds of $3.3
million and asset-backed securities of $1.8 million as of June 30, 2008.(5)
    
    Other investments and loans includes $1.7 million of preferred shares of CDOs owned by
DCM and considered assets of our Investment Management segment. Residential Mortgage-Backed Securities
  June 30, 2008Agency
    
    
    AAA ratedRMBS
    
    
    non-Agency RMBS
    
    
    Total(In thousands)Trading RMBS securities  fair value
    
    $
    415,336
    
    
    $
    28,849
    
    
    $
    444,185
   45




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##### Table of Contents



Leverage.
  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
    
    $
    45,071
    
    
    $
    45,086
    
    
    
    5.57
    %
    
    
    5
    
    
    
    4.63
    %
    
    
    12/36
    
    
    
    17.4
    
    
    
    1.1Rate reset in 1 to 3 years
    
    
    224,061
    
    
    
    225,950
    
    
    
    4.83
    %
    
    
    19
    
    
    
    4.47
    %
    
    
    2/35
    
    
    
    11.0
    
    
    
    1.6Rate reset in 3 to 5 years
    
    
    89,069
    
    
    
    90,205
    
    
    
    5.13
    %
    
    
    40
    
    
    
    4.71
    %
    
    
    9/35
    
    
    
    10.2
    
    
    
    2.6Rate reset in 7 to 10 years
    
    
    38,355
    
    
    
    32,792
    
    
    
    5.62
    %
    
    
    90
    
    
    
    8.02
    %
    
    
    2/36
    
    
    
    7.0
    
    
    
    6.5Fixed Rate RMBS:30 year
    
    
    57,488
    
    
    
    50,152
    
    
    
    6.11
    %
    
    
    n/a
    
    
    
    8.13
    %
    
    
    6/35
    
    
    
    10.7
    
    
    
    7.1Total hybrid and fixed rate RMBS
    
    $
    454,044
    
    
    $
    444,185
 
 (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.n/a  not applicable     46




---



##### Table of Contents



June 30, 2008Amortized
    
    
    FairExpected Life
    
    Cost
    
    
    Value(In thousands)Greater than one year and less than five years
    
    $
    28,345
    
    
    $
    27,719Greater than five years and less than ten years
    
    
    387,200
    
    
    
    382,391Greater than ten years
    
    
    37,852
    
    
    
    34,075Total
    
    $
    453,397
    
    
    $
    444,185
  U.S. Treasury Bills
  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
    
    $
    257,939
    
    
    $
    
    
    
    $
    257,939Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    
    
    
    
    259,577
    
    
    
    259,577Loans held in Wachovia Facility
    
    
    4,484
    
    
    
    85,143
    
    
    
    89,627Other corporate leveraged loans
    
    
    
    
    
    
    24,879
    
    
    
    24,879Commercial real estate loans
    
    
    2,136
    
    
    
    14,064
    
    
    
    16,200$
    264,559
    
    
    
    383,663
    
    
    
    648,222Allowance for loan losses
    
    
    
    
    
    
    (7,883
    )
    
    
    (7,883
    )$
    375,780
    
    
    $
    640,339
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value. Loans Held in Market Square CLO
  47




---



##### Table of Contents



Estimated
    
    
    Weighted AverageMoodys
    
    Par
    
    
    Carrying
    
    
    Fair
    
    
    
    
    
    
    ContractualRating
    
    Value
    
    
    Value
    
    
    Value
    
    
    Spread
    
    
    Maturity(In thousands)
    
    
    
    
    
    
    (Month/Year)Baa3
    
    $
    3,847
    
    
    $
    3,829
    
    
    $
    3,829
    
    
    
    2.25
    %
    
    
    05/13Ba1
    
    
    16,304
    
    
    
    15,828
    
    
    
    15,833
    
    
    
    1.74
    %
    
    
    03/12Ba2
    
    
    16,566
    
    
    
    15,929
    
    
    
    15,948
    
    
    
    1.78
    %
    
    
    10/13Ba3
    
    
    39,497
    
    
    
    35,236
    
    
    
    35,351
    
    
    
    2.22
    %
    
    
    03/13B1
    
    
    75,030
    
    
    
    69,235
    
    
    
    69,476
    
    
    
    2.56
    %
    
    
    08/13B2
    
    
    88,160
    
    
    
    80,842
    
    
    
    81,000
    
    
    
    2.88
    %
    
    
    03/13B3
    
    
    30,243
    
    
    
    25,994
    
    
    
    25,997
    
    
    
    3.26
    %
    
    
    04/13Caa1
    
    
    8,519
    
    
    
    7,183
    
    
    
    7,183
    
    
    
    3.63
    %
    
    
    03/13Caa2
    
    
    5,170
    
    
    
    3,199
    
    
    
    3,199
    
    
    
    3.54
    %
    
    
    11/12Caa3
    
    
    973
    
    
    
    664
    
    
    
    664
    
    
    
    4.25
    %
    
    
    07/11$
    284,309
    
    
    $
    257,939
    
    
    $
    258,480
    
    
    
    2.65
    %
  Loans Held in DFR MM CLO
  WeightedCarrying
    
    
    AverageType of Loan
    
    Value
    
    
    Coupon(In thousands)First lien secured
    
    $
    80,659
    
    
    
    8.46
    %Second lien secured
    
    
    155,835
    
    
    
    9.39
    %Mezzanine
    
    
    23,083
    
    
    
    14.25
    %$
    259,577
    
    
    
    9.53
    %
 Liabilities.
  48




---



##### Table of Contents



Other Corporate Leveraged Loans
  WeightedCarrying
    
    
    AverageType of Loan
    
    Value
    
    
    Coupon(In thousands)First lien secured loans
    
    $
    13,772
    
    
    
    8.40
    %Second lien secured loans
    
    
    63,697
    
    
    
    9.83
    %Mezzanine
    
    
    21,971
    
    
    
    17.12
    %Holding company
    
    
    15,066
    
    
    
    10.50
    %114,506
    
    
    
    11.15
    %Allowance for loan losses
    
    
    (7,500
    )$
    107,006
  Commercial Real Estate Loans
    Preferred shares of CDOs
  49




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##### Table of Contents



Derivatives and Hedging
  Notional
    
    
    
    
    
    
    
    
    
    
    Estimated NetCount
    
    
    Amount
    
    
    Assets
    
    
    Liabilities
    
    
    Fair Value(In thousands)Interest rate swaps
    
    
    18
    
    
    $
    454,000
    
    
    $
    184
    
    
    $
    (6,043
    )
    
    $
    (5,859
    )Interest rate cap
    
    
    1
    
    
    
    40,000
    
    
    
    
    
    
    
    (107
    )
    
    
    (107
    )Credit default swaps  protection seller
    
    
    3
    
    
    
    11,000
    
    
    
    28
    
    
    
    (151
    )
    
    
    (123
    )Total return swaps
    
    
    2
    
    
    
    14,406
    
    
    
    63
    
    
    
    (495
    )
    
    
    (432
    )Warrants
    
    
    4
    
    
    
    n/a
    
    
    
    1,505
    
    
    
    
    
    
    
    1,50528
    
    
    $
    519,406
    
    
    $
    1,780
    
    
    $
    (6,796
    )
    
    $
    (5,016
    )
 ,
   50




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##### Table of Contents



Results of Operations
  Summary
  Three Months Ended June 30,
    
    Six Months Ended June 30,2008
    
    2007
    
    2008
    
    2007(In millions, except for per share data)Consolidated Statements of Operations Data:Net interest income after provision for loan losses
    
    $
    7.1
    
    
    $
    22.0
    
    
    $
    18.7
    
    
    $
    44.1Investment advisory fees
    
    $
    12.4
    
    
    $
    
    
    
    $
    24.5
    
    
    $
    Total expenses
    
    $
    16.9
    
    
    $
    5.2
    
    
    $
    61.1
    
    
    $
    11.9Net other income and (loss) gain
    
    $
    6.0
    
    
    $
    (2.5
    )
    
    $
    (444.3
    )
    
    $
    5.0Net income (loss)
    
    $
    5.7
    
    
    $
    14.5
    
    
    $
    (457.9
    )
    
    $
    37.0Net income (loss) per share  diluted
    
    $
    0.08
    
    
    $
    0.28
    
    
    $
    (7.37
    )
    
    $
    0.72Dividends:Dividends declared (1)
    
    $
    
    
    
    $
    21.7
    
    
    $
    
    
    
    $
    43.5Dividends declared per common share outstanding
    
    $
    
    
    
    $
    0.42
    
    
    $
    
    
    
    $
    0.84Consolidated Balance Sheet Data (as of):Residential mortgage-backed securities
    
    $
    444.2
    
    
    $
    7,753.3
    
    
    $
    444.2
    
    
    $
    7,753.3U.S. Treasury bills
    
    $
    1,000.0
    
    
    $
    
    
    
    $
    1,000.0
    
    
    $
    Total assets
    
    $
    2,434.7
    
    
    $
    9,107.6
    
    
    $
    2,434.7
    
    
    $
    9,107.6Repurchase agreements
    
    $
    1,409.0
    
    
    $
    7,348.5
    
    
    $
    1,409.0
    
    
    $
    7,348.5Long-term debt:Wachovia Facility
    
    $
    53.4
    
    
    $
    318.0
    
    
    $
    53.4
    
    
    $
    318.0Market Square CLO
    
    $
    276.0
    
    
    $
    276.0
    
    
    $
    276.0
    
    
    $
    276.0DFR MM CLO
    
    $
    231.0
    
    
    $
    
    
    
    $
    231.0
    
    
    $
    Pinetree CDO
    
    $
    
    
    
    $
    287.6
    
    
    $
    
    
    
    $
    287.6Trust preferred securities
    
    $
    123.7
    
    
    $
    123.7
    
    
    $
    123.7
    
    
    $
    123.7Series A Notes & Series B Notes
    
    $
    71.4
    
    
    $
    
    
    
    $
    71.4
    
    
    $
    Stockholders equity
    
    $
    224.8
    
    
    $
    676.2
    
    
    $
    224.8
    
    
    $
    676.2Metrics (as of):Book value per share outstanding
    
    $
    3.37
    
    
    $
    13.07
    
    
    $
    3.37
    
    
    $
    13.07Leverage (2)
    
    
    9.6
    
    
    
    12.3
    
    
    
    9.6
    
    
    
    12.3AUM (as of):Investment Management segment (3) (4)
    
    $
    12,976.3
    
    
    $
    
    
    
    $
    12,976.3
    
    
    $
    Principal Investing segment (5)
    
    $
    2,097.4
    
    
    $
    8,829.2
    
    
    $
    2,097.4
    
    
    $
    8,829.2
 
 (1)
    
    Dividends shown are reflected in the period to which they relate, rather than the period
declared.(2)
    
    Leverage is calculated by dividing our total debt (principal outstanding on repurchase
agreements, short term debt and long term debt) by total stockholders equity.(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 $295.3 million and $300.8 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 $7.9 million as of June 30, 2008. 51




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##### Table of Contents



Results of Operations by Segment
  Three months ended June 30, 2008Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    Consolidated(In thousands)Net revenues
    
    $
    15,355
    
    
    $
    8,529
    
    
    $
    (4,424
    ) (1)
    
    $
    19,460Expenses
    
    
    (13,277
    )
    
    
    (8,095
    )
    
    
    4,424
    (1)
    
    
    (16,948
    )Other income and gain (loss)
    
    
    (871
    )
    
    
    6,919
    
    
    
    
    
    
    
    6,048Income tax (expense) benefit
    
    
    (479
    )
    
    
    (2,389
    )
    
    
    
    
    
    
    (2,868
    )Net income
    
    $
    728
    
    
    $
    4,964
    
    
    $
    
    
    
    $
    5,692
 Six months ended June 30, 2008Investment
    
    
    PrincipalManagement
    
    
    Investing
    
    
    Eliminations
    
    
    Consolidated(In thousands)Net revenues
    
    $
    29,803
    
    
    $
    21,708
    
    
    $
    (8,382
    ) (1)
    
    $
    43,129Expenses
    
    
    (55,058
    )
    
    
    (14,395
    )
    
    
    8,382
    (1)
    
    
    (61,071
    )Other income and
gain (loss)
    
    
    (2,982
    )
    
    
    (441,328
    )
    
    
    
    
    
    
    (444,310
    )Income tax
(expense) benefit
    
    
    8,191
    
    
    
    (3,857
    )
    
    
    
    
    
    
    4,334Net loss
    
    $
    (20,046
    )
    
    $
    (437,872
    )
    
    $
    
    
    
    $
    (457,918
    )
 
 (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. 52




---



##### Table of Contents



Investment Management Segment
  Revenues
  Three months ended
    
    
    Six months endedJune 30, 2008
    
    
    June 30, 2008(In thousands)Investment Management Segment RevenuesInterest income
    
    $
    155
    
    
    $
    497Interest expense
    
    
    1,583
    
    
    
    3,554Net interest income (expense)
    
    
    (1,428
    )
    
    
    (3,057
    )Investment advisory fees (1)
    
    
    16,783
    
    
    
    32,860Total Investment Management
segment revenues
    
    $
    15,355
    
    
    $
    29,803
 
 (1)
    
    Investment advisory fees include intercompany investment advisory fees of $4.4 million and
$8.4 million for the three and six months ended June 30, 2008, respectively, calculated in
conjunction with our management agreement, which are eliminated upon consolidation. Net Interest Income
  Investment Advisory Fees
  CDOs
  Three months ended June 30, 2008Senior Management
    
    
    Subordinated
    
    
    
    
    
    
    Total CDO AdvisoryFees
    
    
    Management Fees
    
    
    Performance Fees (1)
    
    
    Fees(In thousands)CLOs
    
    $
    2,157
    
    
    $
    3,521
    
    
    $
    
    
    
    $
    5,678ABS
    
    
    1,369
    
    
    
    71
    
    
    
    2,702
    (2)
    
    
    4,142Investment grade credit
    
    
    230
    
    
    
    54
    
    
    
    
    
    
    
    284Total CDOs
    
    $
    3,756
    
    
    $
    3,646
    
    
    $
    2,702
    
    
    $
    10,104Six months ended June 30, 2008Senior Management
    
    
    Subordinated
    
    
    
    
    
    
    Total CDO AdvisoryFees
    
    
    Management Fees
    
    
    Performance Fees (1)
    
    
    Fees(In thousands)CLOs
    
    $
    4,795
    
    
    $
    6,763
    
    
    $
    
    
    
    $
    11,558ABS
    
    
    2,826
    
    
    
    288
    
    
    
    2,774
    (2)
    
    
    5,888Investment grade credit
    
    
    452
    
    
    
    137
    
    
    
    
    
    
    
    589Total CDOs
    
    $
    8,073
    
    
    $
    7,188
    
    
    $
    2,774
    
    
    $
    18,035
 
 (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 three and six months ended June 30, 2008 included a non-recurring
performance fee of $2.7 million received from one of our ABS CDOs. 53




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##### Table of Contents



Three months ended June 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)
    
    $
    5,043,703
    
    
    
    0.17
    %
    
    
    0.28
    %
    
    
    0.20
    %
    
    
    0.29
    %ABS:High-grade ABS
    
    
    3,666,061
    
    
    
    0.05
    %
    
    
    0.00
    %
    
    
    0.05
    %
    
    
    0.06
    %Other ABS
    
    
    2,857,233
    
    
    
    0.13
    %
    
    
    0.01
    %
    
    
    0.14
    %
    
    
    0.19
    %Total ABS
    
    
    6,523,294
    
    
    
    0.08
    %
    
    
    0.00
    %
    
    
    0.09
    %
    
    
    0.11
    %Investment grade
credit
    
    
    631,058
    
    
    
    0.15
    %
    
    
    0.03
    %
    
    
    0.20
    %
    
    
    0.20
    %Total CDOs
    
    $
    12,198,055
    
    
    
    0.12
    %
    
    
    0.12
    %
    
    
    0.14
    %
    
    
    0.19
    %Six months ended June 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)
    
    $
    5,149,811
    
    
    
    0.19
    %
    
    
    0.26
    %
    
    
    0.21
    %
    
    
    0.29
    %ABS:High-grade ABS
    
    
    3,713,271
    
    
    
    0.05
    %
    
    
    0.01
    %
    
    
    0.05
    %
    
    
    0.06
    %Other ABS
    
    
    2,937,451
    
    
    
    0.13
    %
    
    
    0.01
    %
    
    
    0.14
    %
    
    
    0.19
    %Total ABS
    
    
    6,650,722
    
    
    
    0.08
    %
    
    
    0.01
    %
    
    
    0.09
    %
    
    
    0.11
    %Investment grade credit
    
    
    638,939
    
    
    
    0.14
    %
    
    
    0.04
    %
    
    
    0.20
    %
    
    
    0.20
    %Total CDOs
    
    $
    12,439,472
    
    
    
    0.13
    %
    
    
    0.12
    %
    
    
    0.14
    %
    
    
    0.19
    %
 
 (1)
    
    Average AUM is calculated as the average of the April 1, May 1 and June 1, 2008 AUM for the
three months ended June 30, 2008 and the average of the January 1, February 1, March 1, April
1, May 1, and June 1, 2008 AUM for the six months ended June 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 collateralized loan
obligation, or CLO, AUM total includes AUM related to our structured loan fund.(2)
    
    The effective rate for the three months ended June 30, 2008 is calculated by taking the
management fees earned during the three months ended June 30, 2008 multiplied by four (to
annualize) and divided by the average AUM. The effective rate for the six months ended June
30, 2008 is calculated by taking management fees earned during the period multiplied by two
(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 calculated
as the sum of the amounts 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 CLO has 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. 54




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##### Table of Contents



Termination ofFirst Optional
    
    
    Auction Call
    
    
    Reinvestment
    
    
    MaturityClosing Date
    
    
    July 1, 2008 AUM (1)
    
    
    Call Date (2)
    
    
    Date (3)
    
    
    Period (4)
    
    
    YearMonth/Year
    
    
    (In thousands)
    
    
    Month/YearCLOs:Rosemont CLO, Ltd.
    
    
    01/02
    
    
    $
    187,421
    
    
    
    10/05
    
    
    
    n/a
    
    
    
    01/07
    
    
    
    2013Forest Creek CLO Ltd.
    
    
    05/03
    
    
    
    324,110
    
    
    
    07/07
    
    
    
    n/a
    
    
    
    07/08
    
    
    
    2015Long Grove CLO Ltd.
    
    
    06/04
    
    
    
    400,986
    
    
    
    08/08
    
    
    
    n/a
    
    
    
    05/10
    
    
    
    2016Access Institutional Loan Fund (5)
    
    
    08/04
    
    
    
    126,605
    
    
    Variable
    
    
    n/a
    
    
    
    n/a
    
    
    
    2009
    (9)Castle Harbor II CLO Ltd. (5)
    
    
    12/04
    
    
    
    351,290
    
    
    
    01/10
    
    
    
    n/a
    
    
    
    07/10
    
    
    
    2017Market Square CLO Ltd. (6)
    
    
    05/05
    
    
    
    295,312
    
    
    
    07/07
    
    
    
    n/a
    
    
    
    04/11
    
    
    
    2017Cumberland II CLO Ltd.
    
    
    09/05
    
    
    
    389,402
    
    
    
    02/10
    
    
    
    n/a
    
    
    
    11/11
    
    
    
    2019Marquette Park CLO Ltd.
    
    
    12/05
    
    
    
    301,663
    
    
    
    04/10
    
    
    
    n/a
    
    
    
    01/12
    
    
    
    2020Bridgeport CLO Ltd.
    
    
    06/06
    
    
    
    503,741
    
    
    
    10/09
    
    
    
    n/a
    
    
    
    07/13
    
    
    
    2020Burr Ridge CLO Plus Ltd.
    
    
    12/06
    
    
    
    300,881
    
    
    
    06/12
    
    
    
    n/a
    
    
    
    03/13
    
    
    
    2023Schiller Park CLO Ltd.
    
    
    05/07
    
    
    
    388,805
    
    
    
    07/11
    
    
    
    n/a
    
    
    
    04/13
    
    
    
    2021Bridgeport CLO II Ltd.
    
    
    06/07
    
    
    
    503,231
    
    
    
    12/10
    
    
    
    n/a
    
    
    
    09/14
    
    
    
    2021DFR Middle Market CLO Ltd. (6)
    
    
    07/07
    
    
    
    300,833
    
    
    
    07/10
    
    
    
    n/a
    
    
    
    07/10
    
    
    
    2019Bryn Mawr CLO II Ltd. (5)
    
    
    07/07
    
    
    
    313,961
    
    
    
    08/13
    
    
    
    n/a
    
    
    
    08/14
    
    
    
    2019Gillespie CLO PLC (8)
    
    
    08/07
    
    
    
    463,037
    
    
    
    02/13
    
    
    
    n/a
    
    
    
    08/13
    
    
    
    2023Total Bank Loan CLOs
    
    
    
    
    
    
    5,151,278ABS CDOs:Mid Ocean CBO 2000-1 Ltd.
    
    
    01/01
    
    
    
    139,996
    
    
    
    04/06
    
    
    
    n/a
    
    
    
    01/06
    
    
    
    2036Mid Ocean CBO 2001-1 Ltd.
    
    
    10/01
    
    
    
    141,651
    
    
    
    02/06
    
    
    
    n/a
    
    
    
    01/06
    
    
    
    2036Oceanview CBO I, Ltd.
    
    
    06/02
    
    
    
    222,203
    
    
    
    06/06
    
    
    
    06/12
    
    
    
    06/06
    
    
    
    2032, 2037
    (7)Northlake CDO I, Limited
    
    
    02/03
    
    
    
    201,869
    
    
    
    03/06
    
    
    
    03/13
    
    
    
    03/07
    
    
    
    2033Knollwood CDO Ltd.
    
    
    03/04
    
    
    
    245,636
    
    
    
    04/07
    
    
    
    04/12
    
    
    
    04/08
    
    
    
    2039River North CDO Ltd.
    
    
    01/05
    
    
    
    290,197
    
    
    
    02/09
    
    
    
    02/13
    
    
    
    02/09
    
    
    
    2040Buckingham CDO Ltd.
    
    
    07/05
    
    
    
    894,725
    
    
    
    08/10
    
    
    
    08/13
    
    
    
    08/10
    
    
    
    2040Pinetree CDO Ltd.
    
    
    11/05
    
    
    
    291,474
    
    
    
    01/10
    
    
    
    01/14
    
    
    
    01/10
    
    
    
    2045Buckingham CDO II Ltd.
    
    
    12/05
    
    
    
    1,252,945
    
    
    
    03/11
    
    
    
    03/14
    
    
    
    03/11
    
    
    
    2041Knollwood CDO II Ltd.
    
    
    07/06
    
    
    
    681,513
    
    
    
    07/09
    
    
    
    07/13
    
    
    
    n/a
    
    
    
    2046Buckingham CDO III Ltd.
    
    
    08/06
    
    
    
    1,440,489
    
    
    
    09/11
    
    
    
    09/14
    
    
    
    09/11
    
    
    
    2051Aramis CDO
    
    
    03/07
    
    
    
    233,444
    
    
    
    03/12
    
    
    
    n/a
    
    
    
    n/a
    
    
    
    2047Western Springs CDO Ltd.
    
    
    04/07
    
    
    
    300,390
    
    
    
    07/11
    
    
    
    07/13
    
    
    
    07/11
    
    
    
    2050Total ABS CDOs
    
    
    
    
    
    
    6,336,532Investment Grade Credit CDOs:Valeo Investment Grade CDO Ltd.
    
    
    01/01
    
    
    
    308,150
    
    
    
    01/05
    
    
    
    n/a
    
    
    
    01/06
    
    
    
    2013Valeo Investment Grade CDO II Ltd.
    
    
    05/01
    
    
    
    312,733
    
    
    
    06/05
    
    
    
    n/a
    
    
    
    06/06
    
    
    
    2013Total Investment Grade Credit CDOs
    
    
    
    
    
    
    620,883Total CDO AUM
    
    
    
    
    
    $
    12,108,693
 
 (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 July 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 June 30, 2008.(9)
    
    Subject to a five year extension.  55




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##### Table of Contents



Investment Funds and Separately Managed Accounts
   Number of
    
    AUM as of
    
    ManagementAccounts
    
    July 1, 2008 (1)
    
    Fee Rate
    
    Incentive Fee Rate(in thousands)Fixed income arbitrage investment funds (2)
    
    
    1
    
    
    $
    436,156
    
    
    
    1.50
    %
    
    
    20
    %Separately managed accounts
    
    
    6
    
    
    $
    431,480
    
    
    
    .15%-.30
    %
    
    
    n/a
 
 (1)
    
    AUM is reported as of July 1, 2008, rather than as of June 30, 2008, to be inclusive of
investment fund contributions, if any, effective on the first of the month. The 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.(2)
    
    The Number of Accounts for the fixed income arbitrage investment funds does not include
feeder funds, which are funds that invest all or substantially all of their assets into
trading fund which we manage, although some of our management fees are paid pursuant to
contracts with those feeder funds.n/a
    
     not applicable 56




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##### Table of Contents



Three months ended June 30, 2008
    
    Six months ended June 30, 2008Average
    
    Management
    
    Performance
    
    Average
    
    Management
    
    PerformanceAUM (1)
    
    Fees
    
    Fees
    
    AUM (2)
    
    Fees
    
    Fees(In thousands)Fixed income arbitrage
investment funds
    
    $
    509,036
    
    
    $
    1,992
    
    
    $
    
    
    
    $
    608,450
    
    
    $
    4,748
    
    
    $
    1,186
    
    (3)Separately managed accounts
    
    $
    423,364
    
    
    $
    263
    
    
    
    n/a
    
    
    $
    413,653
    
    
    $
    509
    
    
    
    n/a
 
 (1)
    
    Average AUM is calculated as the average of the AUM on April 1, May 1 and June 1, 2008.(2)
    
    Average AUM is calculated as the average of the AUM on January 1, February 1, March 1, April
1, May 1 and June 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
  57




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##### Table of Contents



Expenses
  Three Months
    
    
    Six Monthsended June 30, 2008(In millions)Salaries
    
    $
    3.4
    
    
    $
    7.7Incentive compensation
    
    
    3.8
    
    
    
    8.2Severance expense
    
    
    0.1
    
    
    
    0.3Employee benefits
    
    
    0.4
    
    
    
    0.9Total compensation and benefits
    
    
    7.7
    
    
    
    17.1Fixed asset depreciation
    
    
    0.3
    
    
    
    0.7Intangible asset amortization
    
    
    2.3
    
    
    
    4.6Total depreciation and amortization
    
    
    2.6
    
    
    
    5.3Audit and audit-related fees
    
    
    0.2
    
    
    
    0.5Other professional fees
    
    
    0.1
    
    
    
    0.1Total professional services
    
    
    0.3
    
    
    
    0.6Insurance expense
    
    
    0.1
    
    
    
    0.3Rent expense
    
    
    0.6
    
    
    
    1.3Software and data feeds
    
    
    0.5
    
    
    
    1.0Other general and administrative fees
    
    
    0.4
    
    
    
    0.5Total general and administrative expense
    
    
    1.5
    
    
    
    2.8Impairment of intangible assets
    
    
    1.1
    
    
    
    9.0Impairment of goodwill
    
    
    
    
    
    
    20.0Total impairment of intangible assets and goodwill
    
    
    1.1
    
    
    
    29.0Total Investment Management segment expenses
    
    $
    13.3
    
    
    $
    55.1
   58




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##### Table of Contents



Other Income and Gain (Loss)
  Income Tax Expense
  Principal Investing Segment
 Revenues
  Three months ended June 30,
    
    
    Variance
    
    
    Six months ended June 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Principal Investing Segment RevenuesInterest income
    
    $
    21.7
    
    
    $
    129.7
    
    
    $
    (108.0
    )
    
    $
    82.7
    
    
    $
    252.4
    
    
    $
    (169.7
    )Interest expense
    
    
    10.9
    
    
    
    102.5
    
    
    
    91.6
    
    
    
    56.5
    
    
    
    201.4
    
    
    
    144.9Net interest income
    
    
    10.8
    
    
    
    27.2
    
    
    
    (16.4
    )
    
    
    26.2
    
    
    
    51.0
    
    
    
    (24.8
    )Provision for loan losses
    
    
    2.3
    
    
    
    5.1
    
    
    
    2.8
    
    
    
    4.5
    
    
    
    6.9
    
    
    
    2.4Total Principal Investing
segment revenues
    
    $
    8.5
    
    
    $
    22.1
    
    
    $
    (13.6
    )
    
    $
    21.7
    
    
    $
    44.1
    
    
    $
    (22.4
    )
  Three months ended June 30,
    
    
    Variance
    
    
    % of total interest income2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    Three months ended June 30,(In millions)
    
    
    2008
    
    
    2007Real Estate Investments:RMBS
    
    $
    6.4
    
    
    $
    99.8
    
    
    $
    (93.4
    )
    
    
    29.5
    %
    
    
    76.9
    %Commercial real estate loans and securities
    
    
    0.7
    
    
    
    1.6
    
    
    
    (0.9
    )
    
    
    3.2
    %
    
    
    1.2
    %ABS held in Pinetree CDO
    
    
    
    
    
    
    5.4
    
    
    
    (5.4
    )
    
    
    0.0
    %
    
    
    4.2
    %Total real estate investments
    
    
    7.1
    
    
    
    106.8
    
    
    
    (99.7
    )
    
    
    32.7
    %
    
    
    82.3
    %Corporate Investments:Corporate loans and securities:Assets held in DFR MM CLO
    
    
    6.9
    
    
    
    
    
    
    
    6.9
    
    
    
    31.9
    %
    
    
    0.0
    %Assets held in Wachovia Facility
    
    
    2.8
    
    
    
    15.5
    
    
    
    (12.7
    )
    
    
    12.9
    %
    
    
    12.0
    %Other corporate leveraged loans
    
    
    0.4
    
    
    
    1.0
    
    
    
    (0.6
    )
    
    
    1.8
    %
    
    
    0.8
    %High yield corporate bonds
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )
    
    
    0.0
    %
    
    
    0.2
    %Assets held in Market Square CLO
    
    
    4.3
    
    
    
    5.6
    
    
    
    (1.3
    )
    
    
    19.8
    %
    
    
    4.3
    %Treasuries and short-term investments
    
    
    0.2
    
    
    
    0.4
    
    
    
    (0.2
    )
    
    
    0.9
    %
    
    
    0.3
    %Other investments
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    0.0
    %
    
    
    0.1
    %Total corporate investments
    
    
    14.6
    
    
    
    22.9
    
    
    
    (8.3
    )
    
    
    67.3
    %
    
    
    17.7
    %Total interest income
    
    $
    21.7
    
    
    $
    129.7
    
    
    $
    (108.0
    )
    
    
    100.0
    %
    
    
    100.0
    %
 59




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##### Table of Contents



Six months ended June 30,
    
    
    Variance
    
    
    % of total interest income2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    Six months ended June 30,(In millions)
    
    
    2008
    
    
    2007Real Estate Investments:RMBS
    
    $
    48.1
    
    
    $
    195.8
    
    
    $
    (147.7
    )
    
    
    58.2
    %
    
    
    77.6
    %Commercial real estate loans and securities
    
    
    1.8
    
    
    
    3.0
    
    
    
    (1.2
    )
    
    
    2.2
    %
    
    
    1.2
    %ABS held in Pinetree CDO
    
    
    
    
    
    
    10.7
    
    
    
    (10.7
    )
    
    
    0.0
    %
    
    
    4.2
    %Total real estate investments
    
    
    49.9
    
    
    
    209.5
    
    
    
    (159.6
    )
    
    
    60.4
    %
    
    
    83.0
    %Corporate Investments:Corporate loans and securities:Assets held in DFR MM CLO
    
    
    15.2
    
    
    
    
    
    
    
    15.2
    
    
    
    18.3
    %
    
    
    0.0
    %Assets held in Wachovia Facility
    
    
    6.2
    
    
    
    28.2
    
    
    
    (22.0
    )
    
    
    7.5
    %
    
    
    11.2
    %Other corporate leveraged loans
    
    
    0.8
    
    
    
    1.6
    
    
    
    (0.8
    )
    
    
    1.0
    %
    
    
    0.6
    %High yield corporate bonds
    
    
    
    
    
    
    0.6
    
    
    
    (0.6
    )
    
    
    0.0
    %
    
    
    0.2
    %Assets held in Market Square CLO
    
    
    9.5
    
    
    
    11.4
    
    
    
    (1.9
    )
    
    
    11.5
    %
    
    
    4.5
    %Treasuries and short-term investments
    
    
    1.1
    
    
    
    1.0
    
    
    
    0.1
    
    
    
    1.3
    %
    
    
    0.4
    %Other investments
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    0.0
    %
    
    
    0.1
    %Total corporate investments
    
    
    32.8
    
    
    
    42.9
    
    
    
    (10.1
    )
    
    
    39.6
    %
    
    
    17.0
    %Total interest income
    
    $
    82.7
    
    
    $
    252.4
    
    
    $
    (169.7
    )
    
    
    100.0
    %
    
    
    100.0
    %
    Three months ended June 30,
    
    
    Variance
    
    
    Six months ended June 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Repurchase agreements
    
    $
    3.1
    
    
    $
    100.8
    
    
    $
    (97.7
    )
    
    $
    34.4
    
    
    $
    198.0
    
    
    $
    (163.6
    )Hedging activity
    
    
    0.1
    
    
    
    (14.9
    )
    
    
    15.0
    
    
    
    5.3
    
    
    
    (29.0
    )
    
    
    34.3Long term debt
    
    
    6.9
    
    
    
    15.0
    
    
    
    (8.1
    )
    
    
    15.9
    
    
    
    29.6
    
    
    
    (13.7
    )Amortization of debt issuance cost
    
    
    0.8
    
    
    
    1.3
    
    
    
    (0.5
    )
    
    
    0.9
    
    
    
    2.5
    
    
    
    (1.6
    )Margin borrowing
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )Total interest expense
    
    $
    10.9
    
    
    $
    102.5
    
    
    $
    (91.6
    )
    
    $
    56.5
    
    
    $
    201.4
    
    
    $
    (144.9
    )
   60




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##### Table of Contents



Provision for Loan Losses
   Expenses
  Three months ended June 30,
    
    
    Variance
    
    
    Six months ended June 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Base management fee expense (1)
    
    $
    4.4
    
    
    $
    3.3
    
    
    $
    1.1
    
    
    $
    8.4
    
    
    $
    6.6
    
    
    $
    1.8Amortization related to restricted stock and options
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    
    
    
    
    0.2
    
    
    
    (0.2
    )Incentive fee expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.2
    
    
    
    (2.2
    )Total management and incentive fee expense to
related party
    
    
    4.4
    
    
    
    3.4
    
    
    
    1.0
    
    
    
    8.4
    
    
    
    9.0
    
    
    
    (0.6
    )Audit and audit-related fees
    
    
    0.2
    
    
    
    0.3
    
    
    
    (0.1
    )
    
    
    0.9
    
    
    
    0.7
    
    
    
    0.2Legal fees
    
    
    1.6
    
    
    
    0.2
    
    
    
    1.4
    
    
    
    1.7
    
    
    
    0.3
    
    
    
    1.4Other professional fees
    
    
    0.2
    
    
    
    0.3
    
    
    
    (0.1
    )
    
    
    0.5
    
    
    
    0.4
    
    
    
    0.1Total professional services
    
    
    2.0
    
    
    
    0.8
    
    
    
    1.2
    
    
    
    3.1
    
    
    
    1.4
    
    
    
    1.7Insurance expense
    
    
    0.6
    
    
    
    0.2
    
    
    
    0.4
    
    
    
    1.2
    
    
    
    0.3
    
    
    
    0.9Board of directors fees
    
    
    0.9
    
    
    
    0.5
    
    
    
    0.4
    
    
    
    1.1
    
    
    
    0.6
    
    
    
    0.5Banking and other administrative fees
    
    
    0.1
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.1Software and data feeds
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    Other general and administrative fees
    
    
    0.1
    
    
    
    0.1
    
    
    
    
    
    
    
    0.1
    
    
    
    0.2
    
    
    
    (0.1
    )Total general and administrative expense
    
    
    1.1
    
    
    
    0.8
    
    
    
    0.3
    
    
    
    1.7
    
    
    
    1.2
    
    
    
    0.5Total Principal Investing segment expenses
    
    $
    8.1
    
    
    $
    5.2
    
    
    $
    2.9
    
    
    $
    14.4
    
    
    $
    11.9
    
    
    $
    2.5
 
 (1)
    
    Base management fee expense for the three and six months ended June
30, 2008 includes $4.4 million and $8.4 million, respectively, of
management fee expense in conjunction with our new management
agreement with DCM, which are eliminated in consolidation. 61




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##### Table of Contents



Other Income and Gain (Loss)
  Three months ended June 30,
    
    
    Variance
    
    
    Six months ended June 30,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Net realized (loss) gain on available-for-sale securities
    
    $
    
    
    
    $
    (0.2
    )
    
    $
    0.2
    
    
    $
    
    
    
    $
    2.5
    
    
    $
    (2.5
    )Other-than-temporary impairment on available-for-sale
securities
    
    
    (3.9
    )
    
    
    
    
    
    
    (3.9
    )
    
    
    (3.9
    )
    
    
    (0.2
    )
    
    
    (3.7
    )Net (loss) gain on available-for-sale securities
    
    
    (3.9
    )
    
    
    (0.2
    )
    
    
    (3.7
    )
    
    
    (3.9
    )
    
    
    2.3
    
    
    
    (6.2
    )Net realized (loss) gain on trading securities
    
    
    (0.1
    )
    
    
    0.3
    
    
    
    (0.4
    )
    
    
    (169.2
    )
    
    
    0.4
    
    
    
    (169.6
    )Net unrealized loss on trading securities
    
    
    (0.8
    )
    
    
    (6.0
    )
    
    
    5.2
    
    
    
    (30.3
    )
    
    
    (3.4
    )
    
    
    (26.9
    )Net loss on trading securities
    
    
    (0.9
    )
    
    
    (5.7
    )
    
    
    4.8
    
    
    
    (199.5
    )
    
    
    (3.0
    )
    
    
    (196.5
    )Net realized (loss) gain on loans
    
    
    (7.7
    )
    
    
    (1.4
    )
    
    
    (6.3
    )
    
    
    (12.6
    )
    
    
    0.2
    
    
    
    (12.8
    )Net unrealized gain (loss) on loans
    
    
    13.2
    
    
    
    (0.1
    )
    
    
    13.3
    
    
    
    (8.4
    )
    
    
    0.3
    
    
    
    (8.7
    )Net gain (loss) on loans
    
    
    5.5
    
    
    
    (1.5
    )
    
    
    7.0
    
    
    
    (21.0
    )
    
    
    0.5
    
    
    
    (21.5
    )Net realized (loss) gain on interest rate swaps
    
    
    (4.8
    )
    
    
    3.2
    
    
    
    (8.0
    )
    
    
    (272.1
    )
    
    
    3.5
    
    
    
    (275.6
    )Net realized (loss) gain on credit default swaps
    
    
    (0.3
    )
    
    
    0.6
    
    
    
    (0.9
    )
    
    
    (2.4
    )
    
    
    1.1
    
    
    
    (3.5
    )Net realized gain (loss) on total return swaps
    
    
    
    
    
    
    0.5
    
    
    
    (0.5
    )
    
    
    (0.7
    )
    
    
    0.2
    
    
    
    (0.9
    )Net realized loss on interest rate floors
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1.6
    )
    
    
    
    
    
    
    (1.6
    )Net unrealized gain (loss) on interest rate swaps
    
    
    9.6
    
    
    
    (0.5
    )
    
    
    10.1
    
    
    
    57.6
    
    
    
    (1.3
    )
    
    
    58.9Net unrealized gain (loss) on credit default swaps
    
    
    0.5
    
    
    
    (0.5
    )
    
    
    1.0
    
    
    
    0.5
    
    
    
    (0.1
    )
    
    
    0.6Net unrealized gain (loss) on total return swaps
    
    
    0.8
    
    
    
    (0.2
    )
    
    
    1.0
    
    
    
    0.3
    
    
    
    0.3
    
    
    
    Net unrealized gain on interest rate floors
    
    
    
    
    
    
    2.2
    
    
    
    (2.2
    )
    
    
    1.1
    
    
    
    1.6
    
    
    
    (0.5
    )Net unrealized gain on warrants
    
    
    0.3
    
    
    
    
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    
    
    
    
    0.2Net gain (loss) on derivatives
    
    
    6.1
    
    
    
    5.3
    
    
    
    0.8
    
    
    
    (217.1
    )
    
    
    5.3
    
    
    
    (222.4
    )Dividend income
    
    
    0.1
    
    
    
    0.1
    
    
    
    
    
    
    
    0.2
    
    
    
    0.2
    
    
    
    Other net loss
    
    
    
    
    
    
    (0.5
    )
    
    
    0.5
    
    
    
    
    
    
    
    (0.3
    )
    
    
    0.3Dividend income and other net loss
    
    
    0.1
    
    
    
    (0.4
    )
    
    
    0.5
    
    
    
    0.2
    
    
    
    (0.1
    )
    
    
    0.3Total other income and gain (loss)
    
    $
    6.9
    
    
    $
    (2.5
    )
    
    $
    9.4
    
    
    $
    (441.3
    )
    
    $
    5.0
    
    
    $
    (446.3
    )Total realized (loss) gain
    
    $
    (12.8
    )
    
    $
    3.1
    
    
    $
    (15.9
    )
    
    $
    (458.4
    )
    
    $
    8.1
    
    
    $
    (466.5
    )Total unrealized gain (loss)
    
    $
    19.7
    
    
    $
    (5.6
    )
    
    $
    25.3
    
    
    $
    17.1
    
    
    $
    (3.1
    )
    
    $
    20.2
   62




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Income Tax Expense
  Off-Balance Sheet Arrangements
  Liquidity and Capital Resources
    
    
    Net loss from trading in securities  $202.5 million
    
    Amortization of net loss on previously designated derivatives  $97.0 million
    
    Net change in operating assets and liabilities  $87.3 million
    
    Impairment on intangible assets and goodwill  $29.0 million
    
    Net loss on loans and loans held for sale  $21.0 million
    
    Depreciation, amortization and non-cash expenses  $5.3 million
    
    Provision for loan losses  $4.5 million
    
    Other-than-temporary impairment on available-for-sale securities  $3.9 million
    
    Net premium and discount amortization  $1.2 million
    
    Share-based compensation  $0.4 million
  
    
    Net loss  $457.9 million
    
    Net purchases of trading securities  $341.8 million
    
    Net changes in undesignated derivatives   $159.9 million
    
    Deferred tax benefit   $12.9 million
    
    Net purchases of loans held for sale  $7.4 million
 63




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##### Table of Contents



Leverage
   Liquidity and Sources of Funds
    64




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##### Table of Contents



Investment Management Segment
  SeriesShort Term
    
    A & BDebt (1)
    
    Notes
    
    Total(In thousands)Outstanding balance
    
    $
    483
    
    
    $
    71,412
    (2)
    
    $
    71,895Weighted average borrowing rate
    
    
    5.61
    %
    
    
    7.70
    %
    
    
    7.69
    %Weighted-average remaining maturity (in years)
    
    
    0.08
    (3)
    
    
    4.50
    
    
    
    4.47Carrying value of collateral (including accrued interest)
    
    $
    1,360
    
    
    $
    197,246
    (4)
    
    $
    198,606
 
 (1)
    
    The short term debt consists of two limited recourse notes collateralized by investments in
preferred shares of CDOs we manage.(2)
    
    Principal outstanding of $71.4 million is presented net of a $2.5 million discount.(3)
    
    The short term debt does not have a stated maturity. The weighted average remaining
maturity is estimated based on the timing of payments of future management fees and preferred
share distributions that are required to be utilized to pay-down the loans.(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.  Principal Investing Segment
  TrustRepurchase
    
    Term
    
    Wachovia
    
    PreferredAgreements
    
    Financing
    
    Facility
    
    Securities
    
    Total(In thousands)Outstanding balance
    
    $
    1,408,955
    
    
    $
    507,000
    (1)
    
    $
    53,412
    
    
    $
    123,717
    
    
    $
    2,093,084Weighted average borrowing rate
    
    
    1.18
    %
    
    
    3.35
    %
    
    
    4.79
    %
    
    
    5.67
    %
    
    
    2.06
    %Weighted-average remaining maturity (in years)
    
    
    0.01
    
    
    
    9.84
    (2)
    
    
    0.69
    
    
    
    27.94
    (3)
    
    
    4.00Carrying value of collateral (including accrued interest)
    
    $
    1,433,133
    
    
    $
    587,736
    
    
    $
    100,999
    
    
    
    n/a
    
    
    $
    2,121,868
 
 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 3.52%, and the weighted-average remaining maturity would be 9.88 years.(2)
    
    $276.0 million of the term financing is callable quarterly, and $231.0 million is callable after July 20, 2010 and quarterly thereafter.(3)
    
    $51.6 million of the trust preferred securities are callable after October 30, 2010, and $72.1 million are callable after October 30, 2011. 65




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##### Table of Contents



Repurchase Agreements.
  Weighted-AverageMaturity of RepurchaseAmount at Risk (1)
    
    
    Agreements(In thousands)
    
    
    (In days)Repurchase Agreement Counterparties:Bank of America Securities LLC
    
    $
    6,530
    
    
    
    1Deutsche Bank Securities Inc.
    
    
    10,064
    
    
    
    8Fortis Securities LLC
    
    
    7,341
    
    
    
    1HSBC Securities (USA), Inc.
    
    
    2,347
    
    
    
    2Total
    
    $
    26,282
    
    
    
    1
 
 (1)
    
    Equal to the fair value of securities pledged (including net additional repurchase agreement
collateral pledged of $1.2 million), minus repurchase agreement liabilities and related accrued interest
payable.  Wachovia Facility.
 Recent
Developments
 66




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##### Table of Contents



Trust Preferred Securities.
  Distribution Policy
    67




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##### Table of Contents



Recent Developments
         68




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##### Table of Contents



Estimated REIT Taxable Income (Loss)
   Six months endedJune 30, 2008(In thousands)GAAP net loss
    
    $
    (457,918
    )Adjustments to GAAP net loss:Difference in rate of amortization and accretion
    
    
    (1,418
    )Interest income on non-accrual loans
    
    
    1,333Tax hedge interest accrual
    
    
    (4,289
    )Tax hedge amortization of deferred swap gains (losses)
    
    
    (50,157
    )Reverse GAAP amortization of swap (gains) losses
    
    
    5,316Provision for loan losses
    
    
    4,502Bad debt expense
    
    
    (1,872
    )Tax capital losses in excess of capital gain
    
    
    312,189Security basis difference upon sale of RMBS
    
    
    (82,140
    )Gain on intercompany sale eliminated for GAAP
    
    
    (567
    )Security basis difference upon sale of other assets
    
    
    311Tax hedge/GAAP trading swap adjustments
    
    
    225,857Other unrealized (gain) loss
    
    
    (17,502
    )Exclusion of taxable REIT subsidiary pre-tax income
    
    
    20,202Income tax expense (benefit)
    
    
    (4,334
    )Other book/tax adjustments
    
    
    33Net adjustments to GAAP net loss
    
    
    407,464Estimated REIT taxable loss
    
    $
    (50,454
    )
  Derivative Instruments and
Hedging Activities
 69




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##### Table of Contents



Inflation
  Seasonality
  
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Interest Rate Risk
  Effect on Net Interest Income
  70




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##### Table of Contents



Year of
    
    NotionalExpiration
    
    Amount(In thousands)2008
    
    $
    243,0002009
    
    
    110,0002010
    
    
    16,0002011
    
    
    2012-2028
    
    
    85,000Total
    
    $
    454,000
  Extension Risk
   Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk
  Interest Rate Mismatch Risk
  71




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##### Table of Contents



Prepayment Risk
  Effect on Fair Value
    Interest Rates
    
    
    
    
    
    Interest RatesFall 100
    
    
    
    
    
    Rise 100Basis Points
    
    Unchanged
    
    Basis Points(In thousands)RMBS
    
    $
    455,191
    
    
    $
    444,185
    
    
    $
    431,377Fair valueChange in fair value
    
    $
    11,006
    
    
    
    
    
    
    $
    (12,808
    )Change as a percent of fair value
    
    
    2.48
    %
    
    
    
    
    
    
    (2.88
    )%Interest Rate Swaps and CapFair value
    
    $
    (12,459
    )
    
    $
    (5,966
    )
    
    $
    85Change in fair value
    
    $
    (6,493
    )
    
    
    
    
    
    $
    6,051Change as a percent of fair value
    
    
    108.84
    %
    
    
    
    
    
    
    (101.42
    )%Net Portfolio Impact
    
    $
    4,513
    
    
    
    
    
    
    $
    (6,757
    )
  72




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##### Table of Contents



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
  Inherent Limitations on Effectiveness of Controls
  73




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##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1A. RISK FACTORS
 Part I  Item 1A. Risk Factors
 We may fail to qualify as a REIT as a result of recent sales of our RMBS securities.
  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.
     74




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Our common stock could be delisted by the New York Stock Exchange if we do not comply with its
continued listing standards
    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.
  
 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.10.1
    
    Letter Agreement between Deerfield Capital Corp. and Peter H. Rothschild, dated
as of July 29, 2008.10.2
    
    Amended and Restated Forebearance Agreement, dated as of August 11, 2008 by and among DWFC, LLC and
Deerfield TRS (Bahamas) Ltd., as borrowers, Deerfield Capital LLC, as originator and servicer,
Wachovia Bank, National Association, as swingline purchaser, Wachovia Capital Markets, LLC, as
administrative agent and VFCC agent, and Wachovia Bank, National Association, as swingline purchaser.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.
 75




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##### Table of Contents



SIGNATURES
  DEERFIELD CAPITAL CORP.(Registrant)Date: August 11, 2008
    
    By: /s/ JONATHAN W. TRUTTER

Jonathan W. Trutter, Chief Executive Officer(Principal Executive Officer)Date: August 11, 2008
    
    By: /s/ RICHARD G. SMITH

Richard G. Smith, Senior Vice Presidentand Chief Financial Officer(Principal Financial and Accounting Officer)
 76