UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

S  QUARTERLY  REPORT PURSUANT TO SECTION
13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period
  ended: June 30, 2005

OR

£ TRANSITION  REPORT PURSUANT TO SECTION
13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _______________

Commission file number: 1-32551

DEERFIELD TRIARC CAPITAL CORP.(Exact name of registrant
as specified in its charter)

|Maryland                                                           | 20-2008622                               
|------------------------------------------------------------------ | -----------------------------------------
|(State or other jurisdiction of
    incorporation or organization) | (I.R.S. Employer
     Identification No.)

| |                                                          |  |           
| | -------------------------------------------------------- |  | ----------
| | 8700 West Bryn Mawr Avenue, 12thFloor, Chicago, Illinois |  | 60631     
| | (Address of principal executive offices)                 |  | (Zip Code)

|                                                                   |                                                                                   
|------------------------------------------------------------------ | ----------------------------------------------------------------------------------
|(773) 380-1600(Registrants telephone number, including area code)
|____________________________________                              
|                                                                   | (Former name, former address and former fiscal year,
if changed since last report)
|                                                                   |                                                                                   

---

Indicate  by check mark whether the registrant (1)
has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934  during  the  preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
£YesSNo
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
£YesSNo
There
  were 51,659,701 shares of the registrants Common Stock outstanding as
  of August 15, 2005.
- 2 -
Part I.    FINANCIAL INFORMATION
**Item 1.   
  Financial Statements (Unaudited)**










DEERFIELD TRIARC CAPITAL CORP.
        CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
        (In thousands, except share and per share amounts)June 30,
      2005
    
    December 31,
    2004ASSETSCash and cash equivalents
    
    $
    130,973
    
    $
    268,686Due from broker
    
    
    1,751
    
    
    Restricted cash and cash equivalents
    
    
    3,824
    
    
    Available-for-sale securities, pledged as collateralat fair value
    
    
    3,219,654
    
    
    327,636Available-for-sale securities  at fair value
    
    
    942,339
    
    
    117,322Held to maturity securities at amortized cost
    
    
    
    
    
    100,125Trading securities at fair value
    
    
    4,983
    
    
    Derivative assets
    
    
    5,264
    
    
    Bank loans held for sale
    
    
    291,643
    
    
    Interest receivable
    
    
    18,600
    
    
    1,211Proceeds receivable from issuance of common stock
    
    
    365,783
    
    
    Other receivable
    
    
    14,098
    
    
    Prepaid asset
    
    
    4,705
    
    
    TOTAL ASSETS
    
    $
    5,003,617
    
    $
    814,980LIABILITIESRepurchase agreements,
    including accrued interest of $16,032 and $22, respectively
    
    $
    3,222,986
    
    $
    317,810Due to broker
    
    
    744,446
    
    
    117,689Dividends declared payable
    
    
    9,569
    
    
    Derivative liabilities
    
    
    5,809
    
    
    276Interest payable
    
    
    13,108
    
    
    Long term debt issuance
    
    
    276,000
    
    
    Management fee payable
    
    
    572
    
    
    160Offering costs payable
    
    
    2,046
    
    
    857Other payables
    
    
    345
    
    
    176TOTAL LIABILITIES
    
    $
    4,274,881
    
    $
    436,968STOCKHOLDERS EQUITYPreferred stock, par value $0.001:100,000,000 shares authorized; none issued and outstanding at
      June 30, 2005 and December 31, 2004
    
    $
    
    
    $
    Common stock, par value $0.001:500,000,000 shares authorized; 51,659,701 shares issued and outstanding
      (including 403,847 restricted shares) at June 30, 2005 and 27,326,986 shares
      issued and outstanding (including 403,847 restricted shares)
      at December 31, 2004
    
    
    51
    
    
    27Additional paid-in capital
    
    
    749,583
    
    
    385,205Deferred equity compensation
    
    
    (5,018
    )
    
    (6,225
    )Accumulated other comprehensive loss
    
    
    (12,617
    )
    
    (704
    )Retained (deficit)
    
    
    
    
    
    (291
    )Distributions in excess of earnings
    
    
    (3,263
    )
    
    TOTAL STOCKHOLDERS EQUITY
    
    
    728,736
    
    
    378,012TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    5,003,617
    
    $
    814,980See notes to condensed consolidated financial statements- 3 -
DEERFIELD TRIARC CAPITAL CORP.CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)
      (In thousands, except share and per share amounts)Three Months
Ended 
June 30, 2005
  
  Six Months 
Ended 
June 30, 2005REVENUESNet interest income:Interest income
     $39,265
        
     $64,543Interest expense
     28,357
        
     44,739Net interest income
     10,908
        
     19,804EXPENSESManagement fee expense to related party
     2,978
        
     5,604Professional services
     210
        
     237Insurance expense
     181
        
     345Other general and administrative expenses
     472
        
     533Total expenses
     3,841
        
     6,719Other gain (loss):Valuation adjustment  on bank loans
     (342
        )
     (633
        )Dividend income
     22
        
     22Loss on sale of available-for-sale securities
     (1,003
        )
     (1,003
        )Loss on sale of bank loans
     (410
        )
     (252
        )Realized gain on designated derivatives
     1,701
        
     1,701Realized gain on undesignated derivatives
     578
        
     578Net change in unrealized appreciation/depreciation
          on undesignated derivatives
     (1,340
        )
     (1,255
        )Net change in unrealized appreciation/depreciation
          on trading securities
     576
        
     503Net loss on investments
     (218
        )
     (339
        )Net Income
     $6,849
        
     $12,746NET INCOME PER SHAREBasic
     $0.25
        
     $0.47NET INCOME PER SHAREDiluted
     $0.25
        
     $0.47WEIGHTED-AVERAGE NUMBER OF SHARES
       OUTSTANDING - Basic
     27,462,671
        
     27,194,396WEIGHTED-AVERAGE NUMBER OF SHARES
       OUTSTANDING - Diluted
     27,554,457
        
     27,255,568See notes to condensed consolidated financial statements- 4 -
DEERFIELD TRIARC CAPITAL CORP.CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (Unaudited) 
      (In thousands)Common Stock
    
    Additional
      Paid-in
    Capital
    
    Deferred
      Equity
    Compensation
    
    Accumulated
      Other
      Comprehensive
    Loss
    
    Retained
    Deficit
    
    Distributions
      In Excess of
    Earnings
    
    Total
    
    Comprehensive
    IncomeShares
    
    Par
    ValueBalance - January 1, 2005
    27,327
    
    $
    27
    
    $
    385,205
    
    $
    (6,225
    )
    $
    (704
    )
    $
    (291
    )
    
    
    
    $
    378,012Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,746
    
    
    
    
    
    12,746
    
    $
    12,746Available-for-sale securities
  fair value adjustment net of
  reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    (13,890
    )
    
    
    
    
    
    
    
    (13,890
    )
    
    (13,890
    )Designated derivatives -
  fair value adjustment net of
  reclassification adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    1,977
    
    
    
    
    
    
    
    
    1,977
    
    
    1,977Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    833Dividends declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12,455
    )
    $
    (3,263
    )
    
    (15,718
    )Issuance of common
      stock
    24,321
    
    
    24
    
    
    365,759
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    365,783Offering costs
    
    
    
    
    
    
    (2,232
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,232
    )Equity issuance costs
    
    
    
    
    
    
    (368
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    (368
    )Stock based compensation
    
    
    
    
    
    
    1,039
    
    
    (1,039
    )
    
    
    
    
    
    
    
    
    
    
    Stock based compensation 
      to board of directors
    12
    
    
    
    
    
    180
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    180Amortization of stock based
      compensation
    
    
    
    
    
    
    
    
    
    2,246
    
    
    
    
    
    
    
    
    
    
    
    2,246BALANCEJune 30, 2005
    51,660
    
    $
    51
    
    $
    749,583
    
    $
    (5,018
    )
    $
    (12,617
    )
    $
    
    
    $
    (3,263
    )
    $
    728,736See notes to condensed consolidated financial statements- 5 -
DEERFIELD
        TRIARC CAPITAL CORP.
      CONSOLIDATED STATEMENTS
        OF CASH FLOWS (Unaudited)
        (In thousands)Six Months
      Ended
      June 30, 2005CASH
      FLOWS FROM OPERATING ACTIVITIESNet Income
    
    
    $
    12,746Adjustments
      to reconcile net income to net cash used in operating activities:Accretion
      of discount on held to maturity securities
    
    
    
    (146
    )Stock
      based compensation to board of directors
    
    
    
    180Amortization
      of net premium on available-for-sale securities
    
    
    
    4,178Amortization
      of stock based compensation
    
    
    
    2,246Amortization
      of debt issuance costs
    
    
    
    50Amortization
      of premium on trading securities
    
    
    
    82Purchase
      premium on undesignated derivative
    
    
    
    (227
    )Unrealized
      gain on designated derivatives
    
    
    
    (12
    )Unrealized
      loss on undesignated derivatives
    
    
    
    1,255Purchase
      of trading securities
    
    
    
    (4,627
    )Unrealized
      gain from trading securities
    
    
    
    (438
    )Proceeds
      from sale of bank loans held for sale
    
    
    
    32,026Purchase
      of bank loans held for sale
    
    
    
    (302,203
    )Change
      in valuation adjustment on bank loans held for sale
    
    
    
    633Principal
      payments on bank loans held for sale
    
    
    
    22,331Net
      realized loss on securities available-for-sale
    
    
    
    1,003Net
      realized gain on designated derivatives
    
    
    
    (1,701
    )Net
      realized gain on undesignated derivatives
    
    
    
    (578
    )Payments
      received on undesignated derivatives
    
    
    
    578Payments
      made on designated derivatives
    
    
    
    (854
    )Changes
      in operating assets and liabilities:Interest
      receivable
    
    
    
    (17,389
    )Prepaid
      assets
    
    
    
    (518
    )Accrued
      interest on repurchase agreements
    
    
    
    16,010Interest
      payable
    
    
    
    16,893Other
      payables
    
    
    
    169Management
      fee payable
    
    
    
    412Net
      cash used in operating activities
    
    
    
    (217,901
    )CASH FLOWS FROM INVESTING
      ACTIVITIESChange in
      restricted cash and cash equivalents
    
    
    
    (3,824
    )Purchase
      of securities available-for-sale
    
    
    
    (3,624,913
    )Proceeds
      from the sale of securities available-for-sale
    
    
    
    369,784Purchase
      of held-to-maturity securities
    
    
    
    (34,719
    )Principal
      payments on available-for-sale securities
    
    
    
    232,758Proceeds
      from the maturity of held-to-maturity securities
    
    
    
    134,990Net
      cash used in investing activities
    
    
    
    (2,925,924
    )CASH FLOWS FROM FINANCING
      ACTIVITIESPayments
      on borrowings under repurchase agreements
    
    
    
    (2,929,499
    )Borrowings
      under repurchase agreements
    
    
    
    5,671,408Issuance
      of debt securities
    
    
    
    276,000Payment
      of debt issuance costs
    
    
    
    (4,237
    )Dividend
      paid
    
    
    
    (6,149
    )Issuance
      of common stock-payment of offering costs
    
    
    
    (1,411
    )Net
      cash provided by financing activities
    
    
    
    3,006,112Net decrease in cash
      and cash equivalents
    
    
    
    (137,713
    )Cash and cash equivalents,
      beginning of period
    
    
    
    268,686Cash and cash equivalents,
      end of period
    
    
    $
    130,973NONCASH INVESTING AND
      FINANCING ACTIVITIES:Unsettled
      available-for-sale purchases - due to broker
    
    
    $
    698,265Unsettled
      bank loan purchases - due to broker
    
    
    $
    46,181Unsettled
      bank loan sales - due from broker
    
    
    $
    1,751Principal
      payments on securities available-for-sale not yet received
    
    
    $
    14,098Warehouse
      participation liability
    
    
    $
    147,258Proceeds
      receivable from issuance of common stock
    
    
    $
    365,783Non
      cash settlement of interest expense
    
    
    $
    3,785Unpaid
      offering costs
    
    
    $
    2,046SUPPLEMENTAL DISCLOSURE:Cash
      paid for interest
    
    
    $
    23,963See notes
      to condensed consolidated financial statements- 6 -
DEERFIELD TRIARC CAPITAL CORP.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)1.
  ORGANIZATIONDeerfield
      Triarc Capital Corp. (the Company) was incorporated as a Maryland
      corporation on November 22, 2004, and commenced its operations of purchasing
      and managing an investment portfolio of real estate related investments,
      primarily mortgage-backed securities, as well as other investment assets.
      On December 23, 2004, the Company completed its initial private placement
      of 27,326,986 shares (including 403,847 restricted shares) of its common
      stock at $15.00 per share that generated net proceeds of approximately $378.9
      million. On July 5, 2005, the Company completed its initial public offering
      (the IPO) of 25,000,000 shares of common stock that generated
      net proceeds of approximately $363.5 million. The Company sold 24,320,715
      common shares at a price of $16.00 per share and selling stockholders sold
      679,285 shares. The Companys stock is listed on the New York Stock
      Exchange under the symbol DFR and began trading on June 29,
      2005.The Company
      has two wholly-owned subsidiaries: Deerfield Triarc Capital LLC (DTC)
      and Deerfield Triarc TRS Holdings, Inc. (TRS Holdings). DTC
      has been the main operating company for the activity since Deerfield Triarc
      Capital Corp.s inception. DTC owns 100% of the equity interest in
      Market Square CLO, LTD. (Market Square), a Cayman Islands limited
      liability company, in the form of preference shares, which is also a variable
      interest entity (VIE). TRS Holdings is the single member parent
      of Deerfield Triarc TRS Holdings, LLC (TRS Holdings LLC). TRS
      Holdings, TRS Holdings LLC and Market Square are taxable real estate investment
      trust subsidiaries (TRS). As of June 30, 2005 and December 31,
      2004, there was no activity in TRS Holdings or TRS Holdings LLC. As of June
      30, 2005, Market Square held a portfolio of bank loans and issued long-term
      debt as described in more detail below. As of June 30, 2005, the Company
      identified another VIE, Pinetree CDO Ltd. (Pinetree) which is
      discussed in more detail below.Deerfield Capital Management LLC (the Manager), pursuant to a management agreement (the
Management Agreement), manages the Company and its investment portfolio. See Note 10
for further discussion related to the Management Agreement.The Company intends to elect to be taxed as a Real Estate Investment Trust (REIT), and
to comply with the provisions of the Internal Revenue Code (the Code), with respect thereto.
See Note 2 for further discussion on income taxes.The interim financial statements as of June 30, 2005 and for the three and six month periods ended
June 30, 2005 are unaudited. However, it is the opinion of the Companys management that all
adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the
Companys financial position, results of operations and cash flows have been included. The nature
of the Companys business is such that the results of any interim period are not necessarily
indicative of results for a full year.2.
  ACCOUNTING POLICIESPrinciples
      of Consolidation The consolidated financial statements include
      the financial statements of the Company and its subsidiaries which are wholly-owned
      and entities which are VIEs in which the Company is the primary beneficiary
      under Financial Accounting Standards Board (FASB) Interpretation
      No. 46 (revised 2003), Consolidation of Variable Interest Entities
      (FIN 46R). All significant inter-company balances and transactions
      have been eliminated in consolidation.- 7 -
Cash and Cash EquivalentsCash and cash equivalents include cash on hand and overnight investments.Restricted Cash and Cash EquivalentsRestricted cash and cash equivalents represent amounts held by third parties for settlement of
certain obligations.SecuritiesThe Company invests primarily in U.S. agency and other highly-rated, residential, hybrid adjustable-rate
mortgage-backed securities issued in the United States market.Statement
      of Financial Accounting Standards (SFAS) No. 115, Accounting
      for Certain Investments in Debt and Equity Securities, requires certain
      investments to be classified as either trading, available-for-sale or held-to-maturity
      investments. Generally, the Company plans to hold a majority of its investments
      for an indefinite period of time, which may be until maturity. However,
      it may, from time to time, decide to sell its investments in response to
      changes in market conditions and in accordance with its investment strategy.
      Accordingly, a significant majority of its investments are classified as
      available-for-sale. All investments classified as available-for-sale are
      reported at fair value, based on quoted market prices provided by independent
      pricing sources when available or quotes provided by dealers who make markets
      in certain securities, with unrealized gains and losses reported as a component
      of accumulated other comprehensive income (loss) in stockholders equity.
      The Company may classify certain short-term securities as held-to-maturity.
      These investments are reported at amortized cost. Periodically, all available-for-sale
      and held-to-maturity investments are evaluated for other-than-temporary
      impairment. Other-than-temporary impairment is a decline in the fair value
      of an investment below its amortized cost attributable to factors that suggest
      the decline will not be recovered over the investments remaining life.
      Other-than-temporary impairments are recognized in the consolidated statement
      of operations. The Company may also classify certain securities acquired
      for speculative trading purposes as trading securities with changes in fair
      value of these securities recognized in the consolidated statement of operations.Interest income is accrued based upon the outstanding principal amount of the securities and their
contractual interest terms. Premiums and discounts are amortized or accreted into interest income
over the estimated lives of the securities using the effective yield method.Security transactions are recorded on the trade date. Realized gains and losses from security transactions
are determined based upon the specific identification method.Bank loans held for sale-The Company may purchase senior secured and unsecured bank loans. The Company classifies these loans
as held for sale and, as a result, the loans are carried at lower of cost or fair market value. If
an individual loans fair market value is less than its cost basis, a valuation adjustment is
recognized in the consolidated statement of operations and the loans cost basis is adjusted
accordingly. A loan may recover its value up to its cost basis in the event the fair market value
increases, which is also recognized in the consolidated statement of operations. Interest income
is accrued based upon the outstanding principal amount of the loans and their contractual interest terms.Derivative Financial InstrumentsThe Company may enter into derivative contracts, including interest rate swaps and interest rate
swap forwards, as a means of mitigating the Companys interest rate risk on forecasted interest
expense associated with the benchmark rate on forecasted rollover/reissuance of repurchase agreements,
or hedged items, for a specified future time period. The Company has designated these transactions
as cash flow hedges. The contracts, or hedge instruments, are evaluated at inception and on an on-going
basis in order to determine whether they qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted (SFAS No. 133). The hedge instrument must be highly effective
in achieving offsetting changes in the hedged item attributable to the risk being hedged in order
to qualify for hedge accounting. Derivative contracts are carried on the consolidated balance sheet
at fair value. Any ineffectiveness that arises during the hedging relationship is recognized in interest
expense in the consolidated statement of operations. The effective portion of all contract gains
and losses (whether realized or unrealized) excluding the net interest accrual is recorded in other
comprehensive income or loss. Realized gains and losses on terminated contracts are maintained in
accumulated other comprehensive income or loss and amortized into interest income or expense ratably
over the contractual life of the terminated contract unless it is probable that the forecasted rollover/reissuance
of repurchase agreements will not occur. In that case, or if the terminated contract is replaced,
such that the forecasted transaction is hedged by another instrument, realized gain or loss in accumulated
other comprehensive income or loss is reclassified to realized gain or loss in the consolidated statement
of operations.The net interest accrual is reflected as either interest income or expense for the period depending
on the Companys net settlement position for the period.- 8 -
The Company
      may also enter into derivatives that do not qualify for hedge accounting
      under SFAS No. 133. These derivatives are carried at their fair market value
      with changes in value reflected in the consolidated statement of operations.Borrowings
       The Company finances the acquisition of mortgage- and asset-backed
      securities and other securities available for sale and the Market Square
      bank loans primarily through the use of repurchase agreements and securitization
      transactions structured as secured financings. Repurchase agreements are
      carried at their outstanding principal or contractual amounts including
      accrued interest.Due
      from Brokers and Due to BrokersAmounts
      due from brokers and due to brokers generally represent cash balances held
      with brokers as part of margin requirements related to derivatives and settlement
      on trades. Amounts due from brokers and due to brokers are recorded as assets
      and liabilities, respectively.Income
      TaxesThe Company intends to elect to be taxed as a REIT and
      to comply with the provisions of the Code with respect thereto. Accordingly,
      the Company is not subject to Federal or state income tax to the extent
      that its distributions to stockholders satisfy the REIT requirements and
      certain asset, income and stock ownership tests are met.TRS Holdings,
      to the extent of its taxable income, would be subject to federal and state
      income tax. For the three and six month periods ended June 30, 2005, TRS
      Holdings did not have any taxable income.Dividend
      DistributionsOn June 14, 2005, the Company declared a quarterly
      distribution of $0.35 per share of common stock, payable on July 15, 2005
      to stockholders of record as of June 22, 2005. On March 31, 2005, the Company
      declared a quarterly distribution of $0.225 per share of common stock, payable
      on April 29, 2005 to stockholders of record as of March 24, 2005.Equity
      CompensationAs of December 23, 2004, the Company granted 403,847
      shares of restricted stock and options to purchase 1,346,156 shares of common
      stock to its Manager. The Company accounts for the restricted stock and
      stock options granted in accordance with the consensus in Issue 1 of the
      Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments
      that are issued to other than Employees for Acquiring, or in Conjunction
      with Selling, Goods or Services, (EITF 96-18). Pursuant
      to EITF 96-18, the stock and options were recorded at fair value in stockholders
      equity, with an off-setting entry to deferred compensation (a contra-equity
      account). The deferred compensation is amortized ratably over a three year
      tiered vesting period with the amortization expense reflected as management
      fee expense. The fair value of stock and options is adjusted quarterly for
      unvested shares. Changes in such fair value are reflected in the amortization
      expense recognized in that quarter and in future quarters until the stock
      and options are fully vested.On May 24,
      2005, the Company made a stock award to its independent directors of 12,000
      shares that vested immediately. This award was also accounted for in accordance
      with EITF 96-18, with the fair value of the stock at the date of the grant
      recorded as directors compensation expense.Incentive
      CompensationThe Management Agreement provides for the payment
      of an incentive fee to the Manager if the Companys financial performance
      exceeds certain benchmarks. See Note 10 for further discussion on the
      specific terms of the computation and payment of the incentive fee.The incentive
      fee will be paid in both cash and restricted stock. The cash portion of
      the incentive fee is accrued and expensed during the period for which it
      is calculated and earned. The Company accounts for the restricted stock
      portion of the incentive fee in accordance with SFAS No. 123, Accounting
      for Stock Based Compensation, and related interpretations, and EITF
      96-18. No incentive fee was incurred as of June 30, 2005.Net
       Earnings/Loss Per ShareThe Company calculates basic
      net earnings/loss per share by dividing net earnings/loss for the period
      by weighted-average number of shares of its common stock outstanding for
      that period. Diluted earnings/loss per share takes into account the effect
      of dilutive instruments, such as stock options and restricted stock, but
      uses the average share price for the period in determining the number of
      incremental shares that are to be added to the weighted-average number of
      shares outstanding. See Note 9 for further discussion on the computation
      of net earnings/loss per share.- 9 -
Use of EstimatesThe preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Estimates affecting the accompanying
condensed consolidated financial statements include the fair values of mortgage-backed securities
and other investment securities, the fair value of interest rate swaps and interest rate swap forwards,
and the fair value of perfect hypothetical interest rate swaps determined for purposes of calculating
ineffectiveness under SFAS No. 133.Concentrations of Credit Risk and Other Risks and UncertaintiesThe Companys investments are primarily concentrated in securities that pass through collections
of principal and interest from underlying mortgages, and there is a risk that some borrowers on the
underlying mortgages will default. Therefore, mortgage-backed securities may bear some exposure to
credit losses. However, the Company mitigates credit risk by holding securities that are either guaranteed
by government (or government-sponsored) agencies or are of very high credit quality rating.The Company bears certain other risks typical in investing in a portfolio of mortgage-backed securities.
Principal risks potentially affecting the Companys consolidated financial position, consolidated
results of operations and consolidated cash flows include the risks that: (a) interest rate
changes can negatively affect the market value of the Companys mortgage-backed securities,
(b) interest rate changes can influence decisions made by borrowers on the mortgages underlying
the securities to prepay those mortgages, which can negatively affect both cash flows from, and the
market value of, the securities, and (c) adverse changes in the market value of the Companys
mortgage-backed securities and/or the inability of the Company to renew short-term borrowings can
result in the need to sell securities at inopportune times and incur realized losses.Variable Interest EntitiesIn December 2003, the FASB issued FIN 46R. FIN 46R addresses the application of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, to a VIE and generally would require that the assets, liabilities and results of operations of a
VIE be consolidated into the financial statements of the enterprise that has a controlling financial
interest in it. The interpretation provides a framework for determining whether an entity should
be evaluated for consolidation based on voting interests or significant financial support provided
to the entity (variable interests). The Company considers all counterparties to the transaction
to determine whether the counterparty is a VIE and, if so, whether the Companys involvement
with the entity results in a variable interest in the entity. If the Company is determined to have
a variable interest in the entity, an analysis is performed to determine whether the Company is the
primary beneficiary and remains consolidated in the accompanying consolidated financial statements.During March 2005, the Company entered into warehouse and master participation agreements (agreements)
with an affiliate of UBS Securities LLC (UBS). Upon review of the transaction, the Company
determined that Market Square was a VIE under FIN 46R and that the Company was the primary beneficiary.
The Company consolidated Market Square at March 31, 2005. On May 10, 2005, the UBS agreements were
terminated and the warehouse funding liability was replaced with the issuance of long-term debt by
Market Square. The Company owns 100% of the equity issued by Market Square and is deemed to be the
primary beneficiary.During May 2005, the Company entered into warehouse, master repurchase and pledge agreements with an
affiliate of UBS providing that UBS will fund the purchase of asset-backed securities (ABS)
by Pinetree during the warehouse period via a master repurchase agreement with a current weighted
average floating rate of 3.53% at June 30, 2005. In addition, the agreements provide for a guarantee
by the Company to UBS of the first $12 million in losses on the portfolio of ABS. Upon review of
the transaction, the Company determined that Pinetree was a VIE under FIN 46R and that the Company
was the primary beneficiary. As a result, the Company consolidated Pinetree as of June 30, 2005,
even though the Company owns none of its equity. The impact of the consolidation of this VIE on the
June 30, 2005 balance sheet was to:
Increase Available-for-sale securities by $156.8 million, which represents ABS held by
Pinetree.
Increase Interest Receivable by $1.3 million, which represents accrued interest on the
Pinetree ABS.
Increase Repurchase Agreements by $147.7 million, which represents the settlement of the
Pinetree ABS.- 10 -

Increase Due To Broker by $7.7 million, which represents unsettled Pinetree ABS.The Company accrues interest income based on the contractual terms of the Pinetree ABS reflected in interest income and recognizes the repurchase agreement interest as interest expense in the consolidated statement of operations. See Note 7 for further discussion of this transaction.3.
  AVAILABLE-FOR-SALE SECURITIESThe following table summarizes the Companys securities classified as available-for-sale as of
June 30, 2005 and December 31, 2004, which are carried at fair value:Mortgage-Backed
    Securities
    
    Other 
      Investment 
    Securities
    
    Total(In thousands)As of June 30, 2005:Amortized cost
    
    $
    3,991,598
    
    $
    184,746
    
    $
    4,176,344Unrealized gains
    
    
    6,092
    
    
    2,332
    
    
    8,424Unrealized losses
    
    
    (22,015
    )
    
    (760
    )
    
    (22,775
    )Fair value
    
    $
    3,975,675
    
    $
    186,318
    
    $
    4,161,993As of December 31, 2004:Amortized cost
    
    $
    445,413
    
    $
    
    
    $
    445,413Unrealized gains
    
    
    120
    
    
    
    
    
    120Unrealized losses
    
    
    (575
    )
    
    
    
    
    (575
    )Fair value
    
    $
    444,958
    
    $
    
    
    $
    444,958Actual maturities of mortgage-backed securities are generally shorter than stated contractual maturities.
Actual maturities of the Companys mortgage-backed securities are affected by the contractual
lives of the underlying mortgages, periodic payments of principal, and prepayments of principal.The following
      table summarizes the Companys mortgage-backed securities on June 30,
      2005 and December 31, 2004, according to their average expected life classifications:Average Expected Life
    
    Fair Value
    
    Amortized
      Cost
    
    Weighted
      Average
      Coupon(In thousands)
    
    
    (In thousands)June 30, 2005:Less than one year
    
    $
    0
    
    $
    0
    
    
    0.00
    %Greater than one year and less than five years
    
    
    497,874
    
    
    502,251
    
    
    4.46Greater than five years
    
    
    3,477,801
    
    
    3,489,347
    
    
    4.87Total
    
    $
    3,975,675
    
    $
    3,991,598
    
    
    4.83
    %December 31, 2004:Less than one year
    
    $
    0
    
    $
    0
    
    
    0.00
    %Greater than one year and less than five years
    
    
    0
    
    
    0
    
    
    0.00Greater than five years
    
    
    444,958
    
    
    445,413
    
    
    4.44Total
    
    $
    444,958
    
    $
    445,413
    
    
    4.44
    %- 11 -
The average
      expected lives of the mortgage-backed securities at June 30, 2005 and December
      31, 2004 in the tables above are based upon data provided through subscription-based
      financial information services, assuming constant principal prepayment rates
      to the balloon or reset date for each security. The prepayment model considers
      current yield, forward yield, steepness of the yield curve, current mortgage
      rates, mortgage rate of the outstanding loan, loan age, margin and volatility.
      For purposes of this disclosure, average expected life is intended to reflect
      the estimated period of time the securities in the portfolio will remain
      outstanding.The actual
      lives of the mortgage-backed securities in the Companys investment
      portfolio could be longer or shorter than the estimates in the table above
      depending on the actual prepayment rates experienced over the lives of the
      applicable securities and are sensitive to changes in both prepayment rates
      and interest rates.At June 30, 2005 and December 31, 2004, unsettled mortgage security purchases totaled $690.6 million
and $117.7 million, respectively. These purchases settled in July and January 2005, respectively.The following table shows the Companys investments fair value and gross unrealized losses,
aggregated by investment category and length of time that individual securities have been in a continuous
unrealized loss position, at June 30, 2005 and December 31, 2004:Less than 12 Months
    
    TotalFair 
      Value
    
    Gross 
      Unrealized
      Losses
    
    Fair
      Value
    
    Gross 
      Unrealized
      Losses(In thousands)As of June 30, 2005:Mortgage-backed securities
    $
    3,030,495
    
    $
    (22,015
    )
    $
    3,030,495
    
    $
    (22,015
    )Other investment securities
    
    64,655
    
    
    (760
    )
    
    64,655
    
    
    (760
    )Total temporarily impaired
  securities
    $
    3,095,150
    
    $
    (22,775
    )
    $
    3,095,150
    
    $
    (22,775
    )As of December 31, 2004:Mortgage-backed securities
    $
    226,068
    
    $
    (575
    )
    $
    226,068
    
    $
    (575
    )Total temporarily impaired
  securities
    $
    226,068
    
    $
    (575
    )
    $
    226,068
    
    $
    (575
    )The temporary impairment of the available-for-sale securities results from the fair value of the securities falling below the amortized cost basis. As of June 30, 2005 and December 31, 2004, none of the securities held had been downgraded by a credit rating agency since their purchase. Management intends to hold the securities until the fair value of the securities held is recovered, which may be maturity if necessary. As such, management does not believe any securities held are other-than-temporarily impaired at June 30, 2005 and December 31, 2004.- 12 -
4.
    HELD-TO-MATURITY SECURITIESThe Company did not hold any held-to-maturity securities as of June 30, 2005. The following table summarizes the Companys held-to-maturity securities as of December 31, 2004, which are carried at amortized cost:Debt securities issued 
      by US Treasury and 
      Government Agencies(In thousands, except percentage)Cost
    $
    100,075Accretion
    
    50Amortized cost
    $
    100,125All held-to-maturity securities had maturities of less than one year.5.
  TRADING SECURITYThe Company holds a trading security as of June 30, 2005, carried at a fair value of approximately
$5.0 million. Unrealized trading gains were recognized on the security for the three and six month
periods ended June 30, 2005 in the amount of $576,000 and $503,000, respectively. The Company did
not hold any trading securities as of December 31, 2004.6.
  BANK LOANS HELD FOR SALEAt June 30,
      2005, DTC held bank loans with a carrying value of $49.9 million and Market
      Square held bank loans with a carrying value of $242.4 million. Market Square
      recorded a valuation allowance against its loan balance of $633 thousand
      based on analysis of the loan portfolio and secondary market prices. The
      Company held no bank loans at December 31, 2004. See Note 8 for discussion
      of borrowings.At June 30, 2005, the Company had commitments to fund additional bank loans in the amount of $2.9 million.
The timing and amount of these additional fundings are at the discretion of the borrower. The Company
had no commitments to fund additional bank loans at December 31, 2004.7.
  ASSET-BACKED SECURITIES CDO TRANSACTIONIn May 2005, the Company entered into an agreement with UBS who will serve as structurer and placement
agent with respect to the structuring, marketing and placement of several classes of notes to be
issued by Pinetree. The Company agreed to purchase 100% of the equity interest of Pinetree, to be
issued as preference shares, for a purchase price of $12 million. The notes issued by Pinetree will
be secured by a portfolio of ABS.- 13 -
The Company
      also entered into a warehouse agreement with an affiliate of the underwriter
      to finance the acquisition of up to $300 million of ABS by Pinetree. Under
      the terms of the repurchase agreement, prior to the issuance of the Pinetree
      notes, the Company is entitled to the accrued interest on the ABS in excess
      of the financing rate, which at June 30, 2005 is a weighted average of 3.53%.
      If the Pinetree transaction is not consummated or any of the ABS are sold
      prior to the closing of the Pinetree transaction, the Company is entitled
      to bear any resulting gain or collateral loss. The Company is not liable
      for collateral losses in excess of the agreed-upon purchase price of the
      Pinetree preference shares of $12 million.8.
  BORROWINGSThe Company has entered into repurchase agreements with third party financial institutions and securitization
transactions structured as secured financings to finance most of its mortgage- and asset-backed and
other securities and bank loans. Each of the financing vehicles bear floating interest rates based
on a spread above LIBOR. The repurchase agreements are short-term borrowings that bear interest rates
that have historically moved in close relationship to the one-month, two-month or three-month LIBOR.
At June 30, 2005 and December 31, 2004, the Company had repurchase agreements outstanding in the
amount of $3.2 billion and $317.8 million, respectively, with weighted-average borrowing rates
of 3.19% and 2.47%, respectively.At June 30, 2005 and December 31, 2004, the repurchase agreements had remaining weighted average maturities
of 32 and 59 days, respectively and are summarized below:June 30, 2005
    
    December 31, 2004(In thousands, except percentage)Mortgage-backed securities:Amortized cost of securities sold, including accrued interest
    $3,060,973
    
    $328,923Fair market value of securities sold, including accrued interest
   of $12,020 and $1,198, respectively
    $3,054,409
    
    $328,834Repurchase agreement liabilities associated with these securities
    $3,062,201
    
    $317,810Average interest rate of repurchase agreement liabilities
    3.17%
    
    2.47%Other investment securities:Cost of securities sold, including accrued interest
    $177,313
    
    Fair market value of securities sold, including accrued interest
   of $1,618
    $178,883
    
    Repurchase agreement liabilities associated with these securities
    $160,785
    
    Average interest rate of repurchase agreement liabilities
    3.57%
    
    At June 30, 2005 and December 31, 2004, the repurchase agreements had amounts at risk with the following counterparties:- 14 -
Repurchase
      Agreement Counterparties
    Amount
      at Risk(1)
    
    Weighted-Average 
      Remaining Maturity of 
      Repurchase Agreement in DaysJune
      30, 2005
    
    December
      31, 2004
    
    June
      30, 2005
    
    December
      31, 2004(In
      Thousands)Bear
      Stearns & Co., Inc.
    $
    (2,465
    )
    $  3,793
    
    
    27
    
    
    59Cantor
      Fitzgerald Securities
    
    190
    
    
    
    
    28Countrywide
      Securities Corp.
    
    6,927
    
    7,231
    
    
    32
    
    
    59Credit
      Suisse First Boston LLC
    
    592
    
    
    
    
    25Lehman
      Brothers Inc.
    
    97
    
    
    
    
    25Morgan
      Stanley & Co. Incorporated
    
    (11,337
    )
    
    
    
    25Nomura
      Securities International
    
    6,937
    
    
    
    
    54UBS
      Securities LLC
    
    9,365
    
    
    
    
    34Total
    $
    10,306
    
    $  11,024(1)
    Equal to
      the fair value of securities sold, plus accrued interest income, minus repurchase
      agreement liabilities, plus accrued interest expense.Net
      proceeds of $363.5 million from the Companys public share offering
      received on July 5, 2005 were used to repay repurchase agreement obligations
      of $406.0 million that matured during the period from July 7, 2005 to July
      25, 2005. The remainder of the repayments were made from cash on hand. Amounts
      repaid were subsequently reborrowed.On
      May 10, 2005, the warehouse agreements with UBS were terminated and the
      funding liability was replaced with the issuance of long-term debt by Market
      Square.The
      following table summarizes the Company's long-term debt as of June 30, 2005.
      There was no long-term debt outstanding at December 31, 2005.Issue
    Principal
      Amount
    
    RateClass
      A Senior Secured Floating Rate Note, Due 2017
    $
    232,500
    
    3.62%Class B Second
      Priority Deferrable Floating Rate Note, Due 2017
    
    27,000
    
    4.13%Class
      C Third Priority Deferrable Floating Rate Note, Due 2017
    
    8,250
    
    5.26%Class D Fourth
      Priority Deferrable Floating Rate Note, Due 2017
    
    8,250
    
    8.11%$
    276,0009.
    CAPITAL
      STOCK AND EARNINGS PER SHAREOn
      December 23, 2004, the Company completed a private offering of 26,923,139
      shares of common stock, $0.001 par value at an offering price of $15 per
      share, including the purchase of 256,472 shares of common stock by the initial
      purchasers/placement agents pursuant to their over-allotment option. The
      Company received proceeds from these transactions in the amount of $378.9
      million, net of underwriting discounts and commissions, placement agent
      fees and other offering costs.In
      addition, on December 23, 2004 the Company granted 403,847 shares of restricted
      common stock, par value $0.001 and options to purchase 1,346,156 common
      shares at an exercise price of $15 per share, to the Manager (see Note 16).
      The Companys restrictions lapse and full rights of ownership vest
      for one-third of the shares and options on the first anniversary of the
      grant date, for one-third of the shares and options on the second anniversary
      and for the last one-third of the shares and options on the third anniversary.
      Vesting is predicated on the continuing involvement of the Manager in providing
      services to the Company.On
      June 28, 2005 the Company completed a public offering of 25,000,000 shares
      of common stock, $.001 par value at an offering price of $16 per share,
      including sale of 679,285 shares by selling stockholders in the private
      offering. The Company received proceeds from this transaction in the amount
      of $365.7 million, net of underwriting discounts and commissions and placement
      agent fees, on July 5, 2005. The Company incurred other offering costs of
      $2.2 million associated with the offering, primarily for printing and legal
      costs.The
      fair value of the shares of restricted stock as of June 30, 2005 was $6,336,000,
      of which $1,924,000 was expensed as management fee expense for the six month
      period ended June 30, 2005. The fair value of the total option grant as
      of June 30, 2005 was $1,023,000, of which $322,000 was expensed as management
      fee expense for the six month period ended June 30, 2005. The fair value
      of each option grant at June 30, 2005 is $0.76. The fair value of each option
      grant is estimated on the date of grant using the Black-Scholes option-pricing
      model with the following weighted-average assumptions as of June 30, 2005:
      dividend yield of 9.25 percent; expected volatility of 21.29 percent, risk-free
      interest rate of 3.915 percent; and expected life of 9.5 years.The
      fair value of the shares of restricted stock as of December 31, 2004 was
      $6,058,000, of which $91,000 was expensed as management fee expense for
      the period ended December 31, 2004. The fair value of the total option grant
      as of December 31, 2004 was $262,500, of which $4,000 was expensed as management
      fee expense for the- 15 -
period ended December 31, 2004. The fair value of each option grant at December 31, 2004 is $0.195.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions as of December 31, 2004: dividend yield of
13.80 percent; expected volatility of 22.83 percent, risk-free interest rate of 4.247 percent; and
expected life of 10 years.The following table presents a reconciliation of basic and diluted earnings per share for the quarter
and six month period ended June 30, 2005 (in thousands except per share amounts):Three months ended
      June 30, 2005
    
    Six months ended
      June 30, 2005Basic:Net income
    $
    6,849
    
    $
    12,746Weighted-average number of common shares outstanding
    
    27,463
    
    
    27,194Basic net income per share
    $
    0.25
    
    $
    0.47Diluted:Net income
    $
    6,849
    
    $
    12,746Weighted-average number of common shares outstanding
    
    27,463
    
    
    27,194Additional shares due to assumed conversion of
  dilutive instruments
    
    92
    
    
    61Adjusted weighted-average number of common shares outstanding
    
    27,555
    
    
    27,255Diluted net income per share
    $
    0.25
    
    $
    0.47Potentially dilutive shares for the three and six month periods ended June 30, 2005 of 28,721 and 30,954, respectively, relating to stock options are not included in the calculation of diluted net income per share because the effect is anti-dilutive.10.
    THE MANAGEMENT AGREEMENTThe Management Agreement with the Manager provides, among other things, that the Company will pay to
the Manager, in exchange for investment management and certain administrative services, certain fees
and reimbursements, summarized as follows:
A monthly base management fee equal to 1/12 of equity multiplied by 1.75%. Equity as defined by the
Management Agreement represents net proceeds from any issuance of common shares less other offering
related costs plus or less the Companys retained earnings (excluding non-cash equity compensation
incurred in current or prior periods) less any amounts the Company paid for common share repurchases.
The calculation may be adjusted for one-time events due to changes in accounting principles generally
accepted in the United States of America (GAAP) as well as other non-cash charges upon
approval of the independent directors of the Company.
    Incentive
      compensation based on the product of 1) 25% of the dollar amount by which
      A) the Companys net income (before incentive compensation) for a quarter
      per common share (based on weighted average number of actual shares outstanding)
      exceeds B) an amount equal to i) the weighted average share price of common
      shares in the initial offering and subsequent offerings of the Company,
      multiplied by ii) the greater of a) 2.00% and b) 0.50% plus one-fourth of
      the Ten Year Treasury rate for such quarter, multiplied by 2) the weighted
      average number of common shares outstanding for the quarter. The calculation
      may be adjusted for one-time events due to changes in GAAP as well as other
      non-cash charges upon approval of the independent directors of the Company.
Out-of-pocket expenses and certain other costs incurred by the Manager and related directly to the
Company.The base management fee is paid monthly in arrears.- 16 -
The incentive compensation will be paid quarterly. Eighty-five percent of the incentive compensation
will be paid to the Manager in cash and fifteen percent will be paid in the form of a restricted
stock award. The Manager may elect to receive more than 15% of incentive compensation in the form
of common shares. The Managers ownership percentage, direct and indirect, cannot exceed 9.8%.
All shares are fully vested upon issuance, provided that the Manager agrees not to sell such shares
prior to the date that is one year after the date the shares are due and payable. Shares payable
as incentive compensation shall be valued as follows:1)
if such shares are traded on a securities exchange, the value shall be deemed to be the average of
the closing prices of the shares on such exchange over the thirty day period ending three days prior
to the issuance of such shares;2)
if such shares are actively traded over-the-counter, the value shall be deemed to be the average of
the closing bid or sales price as applicable over the thirty day period ending three days prior to
the issuance of such shares; and3)
if there is no active market for such shares, the value shall be the fair market value thereof, as
reasonably determined in good faith by the Board of Directors of the Company.The initial term of the Management Agreement goes through December 31, 2007 and shall be automatically
renewed for a one year term thereafter. With a two-thirds vote of the independent directors, the
independent directors may elect not to renew because of either of the following:
Unsatisfactory performance; and/or
Unfair compensation payable to the Manager and fair compensation cannot be agreed upon between two-thirds
of the independent directors and the Manager;In the event that the Agreement is terminated based on the provision discussed above, the Company shall
pay to the Manager a termination fee equal to the amount of two times the sum of the average annual
based management fee and the average annual incentive compensation earned by the Manager during the
two 12-month periods immediately preceding the date of such termination.The base management fee for the three and six month periods ended June 30, 2005 was approximately $1.7
million and $3.4 million, respectively. Amortization for the three and six month periods ended June
30, 2005 of approximately $1.3 million and $2.2 million, respectively, related to the restricted
stock and stock options granted to the Manager was included in Management fee expense to related
party in the consolidated statement of operations. See footnote 9 for additional information regarding
the grant to the Manager. No incentive fee was earned by the Manager for the three and six month
periods ended June 30, 2005.11.
  RELATED-PARTY TRANSACTIONSAt June 30, 2005 and December 31, 2004, the Company was indebted to the Manager for base management
fees of approximately $572,000 and $160,000, respectively. This amount is included in management
fee payable.The company
      that owns a majority interest in the Manager purchased 1,000,000 shares
      of the Company for $15,000,000 in the December 2004 private offering, representing
      an ownership interest of 1.9% as of June 30, 2005 and 3.7% as of December
      31, 2004 in the Company. Certain members of the executive management team
      of the Manager and its affiliates owned 165,414 and 115,114 shares of the
      Company at June 30, 2005 and December 31, 2004, representing an ownership
      percentage of 0.3% and 0.4%, respectively. Shares owned at December 31,
      2004 were purchased at the same price and terms as those shares purchased
      by third-party investors in the December 2004 private offering and subsequent
      acquisitions were open-market purchases.12.
  FAIR VALUE OF FINANCIAL INSTRUMENTSSFAS No. 107, Disclosure About Fair Value of Financial Instruments, requires disclosure of the fair value of financial instruments for which it is practicable to estimate
that value. The fair value of held-to-maturity securities approximates the amortized cost presented
in the consolidated balance sheet as of December 31, 2004 due to the short-term nature of the investment
and the accretion being based on the market yield for such investments. The fair- 17 -
value of mortgage-backed securities available-for-sale and derivatives is equal to their respective
carrying value presented in the consolidated balance sheets. The fair value of cash and cash equivalents,
interest receivable, repurchase agreements, due to broker, and payables, approximates carrying value
as of June 30, 2005 and December 31, 2004 due to the short-term nature of these instruments.13.
  ACCUMULATED OTHER COMPREHENSIVE LOSSThe following is a summary of the components of accumulated other comprehensive loss as of June 30,
2005 and December 31, 2004:June 30, 2005
    
    December 31,2005(In thousands)Beginning balance
    $
    (704
    )
    $
    Available-for-sale securities:Unrealized loss on securities
    
    (14,893
    )
    
    (455
    )Reclassification adjustment for
   securities sold
    
    1,003
    
    
    Cash flow hedges:Unrealized net gain (loss) on hedges
    
    747
    
    
    (249
    )Deferred gain (loss) on hedges
    
    1,230
    
    
    Ending balance
    $
    (12,617
    )
    $
    (704
    )14.
  INTEREST RATE RISKThe Companys primary component of market risk is interest rate risk. The Company is subject to
interest rate risk in connection with its investments in hybrid adjustable-rate mortgage-backed securities,
its related debt obligations, which are repurchase agreements of limited duration that are periodically
refinanced at current market rates, and its derivative contracts.The Companys strategy includes funding its investments in long-term, hybrid adjustable-rate mortgage-backed
securities with short-term borrowings under repurchase agreements. During periods of rising interest
rates, the borrowing costs associated with those hybrid adjustable rate mortgage-backed securities
tend to increase while the income earned on such hybrid adjustable-rate mortgage-backed securities
(during the fixed-rate component of such securities) may remain substantially unchanged. This results
in a narrowing of the net interest spread between the related assets and borrowings and may even
result in losses.The Company may use interest rate swaps and interest rate swap forwards to manage interest rate risk.
The effectiveness of any derivative transactions will depend significantly upon whether the Company
correctly quantifies the interest rate risk being hedged, execution of and ongoing monitoring of
the Companys hedging activities, and the treatment of such hedging activities for accounting
purposes.The Company intends to fund a substantial portion of its acquisitions of hybrid adjustable-rate mortgage-backed
securities with borrowings that have interest rates based on indices and repricing terms similar
to, but of shorter maturities than, the interest rate indices and repricing terms of the mortgage-backed
securities. Thus, the Company anticipates that in most cases the interest rate indices and repricing
terms of its mortgage assets and its funding sources will not be identical, thereby creating an interest
rate mismatch between assets and liabilities. Therefore, the Companys cost of funds would likely
rise or fall more quickly than would the Companys earnings rate on assets. During periods of
changing interest rates, such interest rate mismatches could negatively impact the Companys
consolidated financial condition, consolidated cash flows and consolidated results of operations.
To mitigate interest rate mismatches, the Company may utilize hedging strategies discussed above
and further in Note 15.Changes in interest rates can also have a significant impact on the prepayment rate of mortgage-backed
securities. Prepayments are the full or partial repayment of principal prior to the original term
to maturity of a mortgage loan and typically occur due to refinancing of mortgage loans. Prepayment
rates for existing mortgage-backed securities- 18 -
generally increase when prevailing interest rates fall below the market rate existing when the underlying mortgages were originated.15.
    DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIESThe Company seeks to mitigate its interest rate risk exposure to the effects of major interest rate changes. Such interest rate risk may arise from the issuance and forecasted rollover of short-term liabilities with fixed rate cash flows or from liabilities with a contractual variable rate based on LIBOR. The Company may use interest rate swaps and interest rate forwards to manage this interest rate risk. Derivative instruments are carried at fair value.The following table is a summary of hedging derivative instruments held as of June 30, 2005:Unrealized
      Gains
    
    Unrealized
      Losses
    
    Estimated
      Fair Value(In thousands)Interest Rate Swaps
    $
    4,960
    
    $
    (4,475
    )
    $
    485Interest Rate Swap Forwards
    
    93
    
    
    (94
    )
    
    (1
    )$
    5,053
    
    $
    (4,569
    )
    $
    484The following table is a summary of hedging derivative instruments held as of December 31, 2004:Unrealized
      Gains
    
    Unrealized
      Losses
    
    Estimated
      Fair Value(In thousands)Interest Rate Swaps
    $
    
    
    $
    (225
    )
    $
    (225
    )Interest Rate Swap Forwards
    
    
    
    
    (51
    )
    
    (51
    )$
    
    
    $
    (276
    )
    $
    (276
    )Cash Flow Hedging StrategiesHedging instruments are designated as cash flow hedges, as appropriate, based upon the specifically
identified exposure, which may be an individual item or a group of similar items. The hedged transaction
is the forecasted interest expense on forecasted rollover/reissuance of repurchase agreements for
a specified future time period and the hedged risk is the variability in those payments due to changes
in the benchmark rate. Hedging transactions are structured at inception so that the notional amounts
of the hedges are matched with an equal amount of repurchase agreements forecasted to be outstanding
in that specified period for which the borrowing rate is not yet fixed. Cash flow hedging strategies
include the utilization of interest rate swaps and interest rate forwards. Any ineffectiveness, which
arises during the hedging relationship, is recognized in interest expense during the period in which
it arises. Prior to the end of the specified hedge period, the effective portion of all contract
gains and losses is recorded in other comprehensive income or loss. Realized gains and losses due
to net settlements on the hedging instruments are reclassified into earnings as an adjustment to
interest expense during the specified hedge time period. Hedging instruments under these strategies
are deemed to be broadly designated to the outstanding repurchase portfolio and the forecasted rollover
thereof. At June 30, 2005 and December 31, 2004, the maximum length of time over which the Company
is hedging its exposure is 10 years and 3 years, respectively.The Company may use interest rate swaps and interest rate swap forwards to hedge the forecasted interest
expense associated with the benchmark rate on forecasted rollover/reissuance of repurchase agreements
for the period defined by maturity of the interest rate swap. Cash flows that occur each time the
swap is repriced will be associated with forecasted interest expense for a specified future period.For the three and six month periods ended June 30, 2005, the Company recognized a increase to interest
expense of $272,000 and a decrease to interest expense of $13,000, respectively, due to ineffectiveness.
As of June 30, 2005, the notional amounts outstanding on interest rate swap and interest rate swap
forward contracts were $1.7 billion and $392 million, respectively. As of December 31, 2004,
the notional amounts of outstanding on interest rate swap and interest rate swap forward contracts
were $154.1 million and $86.6 million, respectively.- 19 -
The Company
      held certain derivatives that did not qualify for hedge accounting as of
      June 30, 2005. These derivatives consisted of one interest rate swap entered
      into in March 2005 with a notional amount of $73.3 million that was entered
      into to serve as an economic hedge against changes in fair value due to
      interest rate movements on a security classified as trading. Accordingly,
      changes in fair value of this derivative are recorded in the consolidated
      statement of operations. As of June 30, 2005, this interest rate swap had
      a fair value of $(1.0 million). The Company also holds a swaption, an option
      to enter into an interest rate swap. As of June 30, 2005, this swaption
      had a fair value of $186,000. The Company held no swaptions at December
      31, 2004. In addition, the Company held eleven credit default swaps, as
      the protection seller, with a notional amount of $29 million. A credit default
      swap, or CDS, is a financial instrument used to transfer the credit risk
      of a reference entity from one party to another for a specified period of
      time. In a standard CDS contract, one party, referred to as the protection
      buyer, purchases credit default protection from another party, referred
      to as the protection seller, for a specific notional amount of obligations
      of a reference entity. For this protection, the protection buyer pays a
      premium to the protection seller. The premium is generally paid quarterly
      in arrears, but may be paid in full upfront in the case of a CDS with a
      short maturity. Generally, if a credit event occurs during the term of the
      CDS, the protection seller pays the protection buyer the notional amount
      and takes delivery of the reference entitiys obligation. CDS are generally
      unconditional, irrevocable and noncancellable. As of June 30, 2005, these
      CDS had a fair value of $(206,000). The Company held no CDS at December
      31, 2004. For the three and six month periods ended June 30, 2005, the unrealized
      gain on the CDS portfolio was $32,000 and $100,000 and the unrealized loss
      was $299,000 and $306,000, respectively.16.
  STOCK INCENTIVE PLANUpon formation of the Company, the 2004 stock incentive plan (the Plan) was adopted for
the purpose of attracting and retaining executive officers, employees, directors and other persons
and entities that provide services to the Company. The stock incentive plan authorizes the issuance
of options to purchase common stock and the grant of stock awards, performance shares and stock appreciation
rights.Up to 2,692,313 shares of common stock are available for issuance under the stock incentive plan. The
share authorization, the incentive stock option limit and the terms of outstanding awards will be
adjusted as the board of directors determines is appropriate in the event of a stock dividend, stock
split, reclassification of shares or similar events. Upon completion of the December 2004 private
offering, the Company granted the Manager 403,847 shares of restricted stock and options to purchase
1,346,156 shares of common stock with an exercise price of $15.00 per share under the Plan. On May
24, 2005, the Company granted its independent directors 12,000 shares of stock under the Plan.*****
- 20 -
Item 2.    Managements Discussion and Analysis of Financial Condition and Results
of Operations
Except where the context suggests otherwise,
the terms we, us and our refer to Deerfield Triarc Capital Corp. and its subsidiaries.
Forward-Looking Statements
Certain
  information contained in this Quarterly Report on Form 10-Q constitutes
  forward-looking statements within the meaning of Section 27A of
  the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
  1934 that are based on our current expectations, estimates and projections.
  Pursuant to those sections, we may obtain a safe harbor for forward-looking
  statements by identifying those and by accompanying those statements with cautionary
  statements, which identify factors that could cause actual results to differ
  from those expressed in the forward-looking statements. Statements that are
  not historical facts, including statements about our beliefs and expectations,
  are forward-looking statements. The words believe, anticipate,
  intend, aim, expect, strive,
  plan, estimate, and project, and similar
  words identify forward-looking statements. Such statements are not guarantees
  of future performance, events or results and involve potential risks and uncertainties.
  Accordingly, actual results and the timing of certain events could differ materially
  from those addressed in forward-looking statements due to a number of factors
  including, but not limited to, changes in interest rates and market values,
  changes in prepayment rates, general economic conditions, and other factors
  not presently identified. Other factors that may impact our actual results are
  discussed in our Registration Statement on Form S-11 (Registration No.
  333-123762) under the section titled Risk Factors. We do not undertake,
  and specifically disclaim, any obligation to publicly release the result of
  any revisions that may be made to any forward-looking statements to reflect
  the occurrence of anticipated or unanticipated events or circumstances after
  the date of such statements.
Overview
We are a specialty finance company formed in November 2004 to invest
in real estate-related securities and various other asset classes. We commenced operations in December
2004. We will elect and intend to qualify to be taxed as a real estate investment trust, or REIT, for federal income tax purposes.
We invest in financial assets and intend to construct an investment portfolio that is leveraged where
appropriate to seek to achieve attractive risk-adjusted returns and that is structured to comply
with the various federal income tax requirements for REIT status and to qualify for an exemption
from the Investment Company Act of 1940, as amended, or 1940 Act. We plan to focus on the following asset classes:

    Real
        estate-related securities, principally residential mortgage-backed securities
        or RMBS, and commercial mortgage-backed securities or CMBS;
    Other asset-backed securities or ABS, including collateralized debt obligations or CDO, and consumer ABS;
    Bank loans, including senior secured and unsecured loans, and related derivatives, including credit default swaps on senior secured loans; and
    Leveraged
        finance instruments, including corporate mezzanine loans, high yield corporate
        bonds, distressed and stressed debt securities and private or registered
        equity investments.We
  completed a private offering of 26,923,139 shares of our common stock in December
  2004 in which we raised net proceeds of approximately $378.9 million. We completed
  our initial public offering of 25,000,000 shares of our common stock, including
  24,320,715 newly issued shares sold by us and 679,285 shares sold by selling
  stockholders, in June 2005 in which we raised net proceeds of approximately
  $363.5 million. We have fully invested the proceeds of our December 2004 private
  offering and at June 30, 2005, we have a portfolio of RMBS and other alternative
  investments of $4.5 billion. We have applied the proceeds of the recent public
  offering to pay down repurchase agreement obligations to create additional leveraging
  capacity. We are externally managed by Deerfield Capital Management LLC, or
  Deerfield Capital, a fixed income asset manager and a Securities and Exchange
  Commission, or SEC, registered investment adviser. Deerfield Capital is a wholly-owned
  subsidiary of Deerfield & Company LLC, or Deerfield.
We earn revenues and generate cash through our investments. We
use a substantial amount of leverage to seek to enhance our returns. We finance each of our investments
with different degrees of leverage. The cost of borrowings to finance our investments comprises a
significant portion of our operating expenses. Our net income will depend on our ability to control
this particular operating expense in relation to our revenues.
- 21 -
A variety of industry and economic factors may impact our financial condition and operating performance. These factors include:
    interest
        rate trends,
    rates
        of prepayment on mortgages underlying our mortage-backed securities, or
        MBS,
    competition,
        and
    other
        market developments.In addition, a variety of factors relating to our business may also impact our financial condition and operating performance. These factors include:
    our
        leverage,
    our
        access to funding and borrowing capacity,
    our
        borrowing costs,
    our
        hedging activities,
    changes
        in the credit ratings of the loans, securities, and other assets we own,
    the
        market value of our investments, and
    REIT
        requirements and the requirements to qualify for an exemption under the
        1940 Act.Our
  income is generated primarily from the net spread, or difference, between the
  interest income we earn on our investment portfolio and the cost of our borrowings
  and hedging activities. Our net interest income will vary based upon, among
  other things, the difference between the interest rates earned on our various
  interest-earning assets and the borrowing costs of the liabilities used to finance
  those investments.
We leverage our investments to seek to enhance our potential returns.
Leverage can enhance returns but also magnifies losses.
We anticipate that, for any period during which our assets are
not match-funded, such assets will reprice more slowly than the corresponding liabilities. Consequently,
changes in interest rates, particularly short-term interest rates, may significantly influence our
net income. Increases in these rates will tend to decrease our net income and the market value of
our assets, and could possibly result in operating losses for us or limit or eliminate our ability
to make distributions to our stockholders.
The yield on our assets may be affected by a difference between
the actual prepayment rates and our
- 22 -
projections. Prepayments on loans and securities may be influenced by changes in market interest rates
and a variety of economic, geographic and other factors beyond our control, and consequently, such
prepayment rates cannot be predicted with certainty. To the extent we have acquired assets at a premium
or discount, a change in prepayment rates may impact our anticipated yield. Under certain interest
rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain assets.
In periods of declining interest rates, prepayments on our investments,
including our RMBS, will likely increase. If we are unable to reinvest the proceeds of such prepayments
at comparable yields, our net interest income may suffer. In periods of rising interest rates, prepayment
rates on our investments, including our RMBS, will likely slow, causing the expected lives of these
investments to increase. This may cause our net interest income to decrease as our borrowing and
hedging costs rise while our interest income on those assets remain constant.
While we use hedging to mitigate some of our interest rate risk,
we do not hedge all of our exposure to changes in interest rates and prepayment rates, as there are
practical limitations to our ability to insulate the portfolio from all of the negative consequences
associated with changes in short-term interest rates while still seeking to provide an attractive
net spread on our portfolio.
In addition, our returns will be affected by the credit performance
of our non-agency investments. If credit losses on our investments or the loans underlying our investments
increase, it may have an adverse affect on our performance.
Deerfield Capital is entitled to receive a base management fee
that is based on the amount of our equity (as defined in the management agreement), regardless of
the performance of our portfolio. Accordingly, the payment of our management fee is a fixed cost
and will not decline in the event of a decline in our profitability and may lead us to incur losses.
Trends
The following trends may also affect our business:
Rising
  interest rate environment.  Interest rates have recently increased
  and may continue to increase. With respect to our existing MBS portfolio, which
  is heavily concentrated in 3-1 and 5-1 hybrid adjustable rate RMBS, such interest
  rate increases should result in decreases in our net interest income, as there
  is a timing mismatch between the reset dates on our MBS portfolio and the financing
  of these investments. We currently have invested and intend to continue to invest
  in hybrid adjustable-rate RMBS which are based on mortgages with interest rate
  caps. The financing of these RMBS is short term in nature and does not include
  an interest rate cap. This mismatch should result in a decrease in our net interest
  income if rates increase sharply after the initial fixed rate period and our
  interest cost increases more than the interest rate earned on our RMBS due to
  the cap. With respect to our existing and future floating rate investments such
  as bank loans, such interest rate increases should result in increases in our
  net
- 23 -
interest income because our
  floating rate assets are greater in amount than the related liabilities. Similarly,
  such an increase in interest rates should generally result in an increase in
  our net interest income on future fixed rate investments made by us because
  our fixed rate assets would be greater in amount than our liabilities. However,
  we would expect that our fixed rate assets would decline in value in a rising
  interest rate environment and our net interest spreads on fixed rate assets
  could decline in a rising interest rate environment to the extent they are financed
  with floating rate debt. We have engaged in interest rate swaps to hedge a significant
  portion of the risk associated with increases in interest rates. However, because
  we do not hedge 100% of the amount of short-term financing outstanding, increases
  in interest rates should result in a decline in the value of our portfolio,
  net of hedges. Similarly, decreases in interest rates should result in an increase
  in the value of our portfolio.
Flattening yield curve. Short-term interest rates have been increasing at a greater rate than longer term interest rates. For example, between December 31, 2004 and June 30, 2005, the yield on the three-month U.S. treasury bill increased by 90 basis points, while the yield on the three-year U.S. treasury note increased by only 42 basis points. With respect to our RMBS portfolio, we believe that a continued flattening of the shape of the yield curve should result in decreases in our net interest income, as the financing of our RMBS investments is usually shorter in term than the fixed rate period of our RMBS portfolio, which is heavily weighted towards 3-1 and 5-1 hybrid adjustable rate RMBS. Similarly, we believe that a steepening of the shape of the yield curve should result in increases in our net interest income. A flattening of the shape of the yield curve results in a smaller gap
between the rate we pay on the swaps and the rate we receive. Furthermore, a continued flattening of the shape of the yield curve should result in a decrease in our hedging costs, since we pay a fixed rate and receive a floating rate under the terms of our swap agreements. Similarly, a steepening of the shape of the yield curve should result in an increase in our hedging costs.
Prepayment rates. Prepayment rates generally increase when interest rates
  fall and decrease when interest rates rise, but changes in prepayment rates
  are difficult to predict. Prepayment rates also may be affected by other factors,
  including, without limitation, conditions in the housing and financial markets,
  general economic conditions and the relative interest rates on adjustable-rate
  and fixed-rate mortgage loans. Because interest rates may continue to increase,
  RMBS prepayment rates may fall. If interest rates
  begin to fall, triggering an increase in prepayment rates, our current portfolio,
  which is heavily weighted towards hybrid adjustable-rate mortgages, would cause
  decreases in our net interest income relating to our RMBS portfolio.
Competition.
  We expect to face increased competition for our targeted investments due to
  potential further tightening of credit spreads. However, we expect that the
  size and growth of the market for these investments will continue to provide
  us with a variety of investment opportunities. In addition, it is likely that
  bank lenders will continue their historical lending practices, requiring low
  loan-to-value ratios and high debt service coverages, which will provide opportunities
  to lenders like us to provide corporate mezzanine financing.
Credit
  spreads. The credit markets have experienced tight
- 24 -
credit spreads due to the
  robust demand for credit and continued economic recovery. With respect to our
  credit portfolio, which includes bank loans, mezzanine and second lien loans,
  preferred shares and other corporate securities and accounts for approximately
  six percent of our total portfolio as of June 30, 2005, a narrowing of credit
  spreads could result in decreases in the net interest income on future credit
  investments.
For a discussion of additional risks relating to our business see
Item 3  Quantitative and Qualitative Disclosures About Risk.
Critical Accounting Policies
Our financial statements are prepared in accordance with generally
accepted accounting principles in the United States, or GAAP. These accounting principles require
us to make some complex and subjective decisions and assessments. Our most critical accounting policies
involve decisions and assessments that could affect our reported assets and liabilities, as well
as our reported revenues and expenses. We believe that all of the decisions and assessments upon
which our financial statements are based were reasonable at the time made based upon information
available to us at that time. We rely on Deerfield Capitals experience and analysis of historical
and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2
to the condensed consolidated financial statements for a complete discussion of our significant accounting
policies. Under different conditions, we could report materially different amounts arising under
these critical accounting policies. We have identified our most critical accounting policies to be the following:
Classifications of Investment Securities
Our investments in MBS and ABS are primarily classified as available-for-sale
securities that are carried on the balance sheet at their fair value. This classification results
in changes in fair value being recorded as balance sheet adjustments to accumulated other comprehensive
income or loss, which is a component of stockholders equity.
Valuations of RMBS and ABS
Our MBS and ABS have fair values as determined with reference to
price estimates provided by independent pricing services and dealers in the securities. Different
judgments and assumptions used in pricing could result in different presentations of value.
When the fair value of an available-for-sale security is less than
its amortized cost for an extended period, we consider whether there is an other-than-temporary impairment
in the value of the security. If, in our judgment, an other-than-temporary impairment exists, the
cost basis of the security is written down to the then-current fair value, and the unrealized loss
is transferred from accumulated other comprehensive loss as an immediate reduction of current earnings
(as if the loss had been realized in the period of other-than-temporary impairment). The determination
of other-than-temporary impairment is a subjective process, and different judgments and assumptions
could affect the timing of loss realization.
- 25 -
We consider the following factors when determining an other-than-temporary impairment for a security or investment:
    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; and
    our
        intent to hold the security for a period of time sufficient to allow for
        any anticipated recovery in market value.The
  determination of other-than-temporary impairment is made at least quarterly.
  If we determine an impairment to be other than temporary we will need to realize
  a loss that would have an impact on future income. We have aggregate unrealized
  holding losses on available-for-sale securities of $22.8 million as of
  June 30, 2005, which, if not recovered, may result in the recognition of future
  losses.
Interest Income Recognition
Interest income on our MBS is accrued based on the actual coupon
rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are
amortized or accreted into interest income over the lives of the securities using a method that approximates
the effective yield method based on Statement of Financial Accounting Standards, or SFAS, No. 91,Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial
Direct Costs of Leases. If our estimate of prepayments is incorrect, we may have to adjust the amortization or accretion of
premiums and discounts, which would impact future income. Net premium amortization expense recognized
for the three- and six-month periods ended June 30, 2005 was $3.1 million and $4.3 million, respectively.
The
  amount of premium amortization we recognize is dependent on estimated prepayment
  rates on underlying securities. Prepayment rates generally increase when interest
  rates fall and decrease when interest rates rise, but changes in prepayment
  rates are difficult to predict. Prepayment rates also may be affected by other
  factors, including, without limitation, conditions in the housing and financial
  markets, general economic conditions and the relative interest rates on adjustable-rate
  and fixed-rate mortgage loans. We have estimated prepayment rates based on historical
  data and consideration of current market conditions. Our total premium amortization
  expense for the three months and six months ended June 30, 2005 was $3.1 million
  and $4.3 million, respectively. As of June 30, 2005, we had approximately
  $51.2 million of unamortized premium included in the cost basis of our
  available for sale securities. Our current average expected life of the portfolio
  is 6.2 years. Accordingly, under current estimates, the unamortized premium
  will be substantially amortized into interest income over that time period.
  We expect amortization expense recorded in interest income to increase in future
  quarters due to the ramp up of our portfolio and the varying purchase dates
  of the underlying securities.
- 26 -
Bank Loans Held for Sale
Our investments in bank loans are classified as held for sale and carried on the balance sheet at the lower of cost or fair market value. We determine fair value using price estimates provided by an independent pricing service. If an individual loans fair market value is below its cost, a valuation adjustment is recognized in our statement of operations and the loans cost basis is adjusted. The reduction to the cost basis of our bank loan portfolio for the three- and six-month periods ended June 30, 2005 was $0.3 million and $0.6 million, respectively. We accrue interest income based on the outstanding principal amounts of the loans and their contractual interest terms.
Accounting For Derivative Financial Instruments and Hedging Activities
Our policies permit us to enter into derivative contracts, including
interest rate swaps and interest rate swap forwards, as a means of mitigating our interest rate risk
on forecasted interest expense associated with the benchmark rate on forecasted rollover/reissuance
of repurchase agreements, or hedged items, for a specified future time period. We currently intend
to use interest rate derivative instruments to mitigate interest rate risk rather than to enhance
returns.
At June 30, 2005, we had engaged in 104 interest rate swaps with
a notional value of $2.1 billion and a fair value of $0.5 million to seek to mitigate our interest
rate risk for the specified future time period, which is defined as the term of the swap contracts.
Based upon the market value of these interest rate swap contracts, our counterparties may request
additional margin collateral or we may request additional collateral from our counterparties to ensure
that appropriate margin account balance is maintained at all times through the expiration of the
contracts.
These contracts, or hedge instruments, have been designated as
cash flow hedges and are evaluated at inception and on an ongoing basis in order to determine whether
they qualify for hedge accounting under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted. We formally document all relevant relationships between hedging instruments
and hedged items, as well as our risk-management objective and strategy for undertaking each hedge
transaction. The hedge instrument must be highly effective in achieving offsetting changes in the
hedged item attributable to the risk being hedged in order to qualify for hedge accounting. In order
to determine whether the hedge instrument is highly effective, we use regression methodology to assess
the effectiveness of our hedging strategies. The derivative contracts are carried on the balance
sheet at fair value. Any ineffectiveness which arises during the hedging relationship is recognized
in interest expense during the period in which it arises. Prior to the end of the specified hedge
time period the effective portion of all contract gains and losses is recorded in other comprehensive
income or loss. Realized gains and losses are reclassified into earnings as an adjustment to interest
expense during the specified hedge time period.
We are not required to account for the derivative contracts using
hedge accounting as described above. If we decide not to designate the derivative contracts as hedges
and to monitor their effectiveness as hedges, or if we
- 27 -
enter into other types of financial instruments that do not meet the criteria to be designated as hedges,
changes in the fair values of these instruments would affect earnings. As of June 30, 2005, we held
one undesignated interest rate swap and eleven undesignated credit default swaps. As of December 31, 2004,
we did not hold any undesignated derivative contracts.
We value both our actual interest rate swaps and hypothetical interest
rate swaps (for purposes of quantifying ineffectiveness) by determining the net present value of
all payments between the counterparties which are calculated based on internally developed and tested
market-standard models that utilize data points obtained from external market sources. The change
in fair value of our designated interest rate swaps for the three- and six-month periods ended June
30, 2005 was ($17.3 million) and $0.8 million, respectively. For the three and six month periods
ended June 30, 2005 we recognized an increase to interest expense of $272,000 and a decrease to interest
expense of $13,000, respectively, due to ineffectiveness. The change in the fair value of our undesignated
interest rate swap for the three- and six-month periods ended June 30, 2005 was ($1.0 million) and
($1.0 million), which was recorded as an unrealized loss in our statement of operations.
The
  fair value of the credit default swaps, or CDS, depends on a number of factors,
  primarily premium levels that are dependent on interest rate spreads. The CDS
  contracts are valued using internally developed and tested market-standard pricing
  models which calculate the net present value of differences between future premiums
  on currently quoted market CDS and the contractual futures premiums on our CDS
  contracts. Our model uses quoted market premium data obtained from prominent
  broker dealers in the CDS market. The net change in the fair value of our CDS
  contracts for the three- and six-month periods ended June 30, 2005 was ($267,000)
  and ($206,000), which was recorded as an unrealized loss in our statement of
  operations.
Management Incentive Compensation Expense
The management agreement provides for the payment of incentive
compensation to Deerfield Capital if our financial performance exceeds certain benchmarks. Incentive
compensation is calculated on a quarterly basis and paid in arrears. Subsequent to each quarter of
the fiscal year, we will calculate whether incentive compensation is payable and, if necessary, record
the accrual in the appropriate quarter. The management agreement provides that 15% of Deerfield Capitals
incentive compensation is to be paid in shares of our common stock (provided that under our management
agreement, Deerfield Capital may not receive payment of its incentive fee in shares of our common
stock if such payment would result in Deerfield Capital owning directly or indirectly through one
or more subsidiaries more than 9.8% of our common stock) and the balance in cash. Deerfield Capital
may, in its sole discretion, elect to receive a greater percentage of its incentive compensation
in the form of our common stock. The number of shares to be received by Deerfield Capital will be
based on the fair market value of the shares. Shares of our common stock delivered as payment of
the incentive fee will be immediately vested or exercisable, provided that Deerfield Capital has
agreed not to sell the shares prior to one year after the date they are paid.
- 28 -
Equity Compensation
We
  account for the restricted stock and stock options granted to Deerfield Capital
  in accordance with the consensus in Issue 1 of EITF 96-18,Accounting
  for Equity Instruments that are issued to other than Employees for Acquiring,
  or in Conjunction with Selling, Goods or Services, or EITF 96-18. Pursuant
  to EITF 96-18, the stock and options were recorded at fair value in stockholders
  equity, with an offsetting entry to deferred compensation (a contra-equity account).
  The deferred compensation is amortized over a three-year tiered vesting period
  with the amortization expense reflected as management fee expense. The fair
  value of stock and options is adjusted quarterly for unvested shares. Changes
  in such fair value are reflected in the amortization expense recognized in that
  quarter and in future quarters until the stock and options are fully vested.
  As a result, changes in our stock price will cause volatility in our financial
  results as reported under GAAP.
Variable Interest Entities
In
  December 2003, the Financial Accounting Standards Board, or FASB, issued Interpretation
  46R,Consolidation of Variable Interest Entities, or FIN 46R. The
  purpose of this interpretation is to provide guidance on how to identify a variable
  interest entity, or VIE, and determine when the assets, liabilities, noncontrolling
  interests, and results of operations of a VIE need to be included in a companys
  consolidated financial statements. A company that holds variable interests in
  an entity will need to consolidate that entity if the companys interest
  in the VIE is such that the company will absorb a majority of the VIEs
  anticipated losses and/or receive a majority of the VIEs expected residual
  returns. As of June 30, 2005, we consolidated two VIEs due to our interest in
  the Pinetree and Market Square transactions. See Item 2Financial
  ConditionAsset Backed Securities and Item 2 Financial
  ConditionLoans Held for Sale for a summary of the Pinetree and Market
  Square transactions.
Income Taxes
We operate in a manner that we believe will allow us to be taxed
as a REIT and, as a result, we do not expect to pay substantial corporate-level income taxes. Many
of the requirements for REIT qualification, however, are highly technical and complex. If we were
to fail to meet these requirements and do not qualify for certain statutory relief provisions, we
would be subject to federal income tax, which could have a material adverse impact on our results
of operations and amounts available for distributions to our stockholders. In addition, Deerfield
Triarc TRS Holdings, Inc., one of our taxable REIT subsidiaries, or TRS, is subject to
corporate-level income taxes.
Financial Condition
All of our assets at June 30, 2005 and December 31, 2004 were
acquired with the proceeds from our December 2004 private offering, operating cash flows and our
use of leverage. We intend to use the proceeds from our June 2005 public offering of our common stock
to create additional leveraging capacity by paying down repurchase agreement obligations.

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Mortgage-Backed Securities
Our mortgage investment strategy of buying higher coupon, higher
premium bonds takes on more prepayment risk than lower dollar-priced strategies. However, we believe
that the potential benefits of our strategy include higher income, wider spreads, and lower hedging
costs due to the shorter option-adjusted duration of the higher coupon security.
The table below summarizes the valuation adjustments on our MBS
investments:
June 30,
      2005
    
    December 31,
      2004(In thousands)Amortized cost
    $
    3,991,598
    
    $
    445,413Unrealized gains
    
    6,092
    
    
    120Unrealized losses
    
    (22,015
    )
    
    (575
    )Fair value
    $
    3,975,675
    
    $
    444,958Certain
of the securities held at June 30, 2005 and December 31, 2004 are valued below cost. We do not
believe any such securities are other-than-temporarily impaired at June 30, 2005 and December 31,
2004 and have the intent and ability to hold these securities until the value is recovered.
As of June 30, 2005 and December 31, 2004, the RMBS in our portfolio were purchased at a net premium
to their par value and our portfolio had a weighted-average amortized cost of 101.3% and 101.2% of
face amount, respectively. The RMBS were purchased at a premium and continued to be valued above
par at June 30, 2005 because the weighted-average coupon of 4.8% and the corresponding interest rates
of loans underlying our RMBS, are above prevailing market rates. Premium bonds tend to have shorter
durations than discount or par bonds and their values are thus less sensitive to interest rate movement.
As of June 30, 2005, the relative fair value of our RMBS portfolio versus its amortized cost declined
from December 31, 2004 due to an increase in prevailing market interest rates. Our net portfolio
duration, which is the difference between the duration of the RMBS portfolio and the duration of
our repurchase agreements, adjusted for the effects of our swap portfolio, declined to 0.1 years at June 30, 2005

- 30 -
Our MBS holdings consist of hybrid RMBS as follows at June 30, 2005:

Weighted AverageSecurity Description
    Par Amount
    
    Estimated
      Fair
      Value
    
    Coupon
    
    Months to
      Reset(1)
    
    Yield to
      Maturity
    
    Constant
      Prepayment
      Rate(in thousands)Agency:3-1 hybrid adjustable rate RMBS
    
    $
    833,839
    
    $
    837,528
    
    4.4
    %
    32.0
    
    4.3
    %
    32.5
    %5-1 hybrid adjustable rate RMBS
    
    
    2,448,088
    
    
    2,476,749
    
    4.9
    
    55.4
    
    4.4
    
    15.97-1 hybrid adjustable rate RMBS
    
    
    52,386
    
    
    53,131
    
    4.9
    
    80.9
    
    4.4
    
    7.110-1 hybrid adjustable rate RMBS
    
    
    135,893
    
    
    137,457
    
    5.2
    
    119.3
    
    4.8
    
    3.7Non-Agency(2):AAA-rated hybrid adjustable rate RMBS
    
    
    303,587
    
    
    306,055
    
    5.4
    
    32.6
    
    5.1
    
    33.2AAA-rated fixed rate RMBS
    
    
    201,088
    
    
    164,755
    
    5.3
    
    n/a
    
    4.8
    
    9.6Total MBS
    
    $
    3,974,881
    
    $
    3,975,675
    
    4.8
    
    49.0
    
    4.3
    
    19.5(1)
    
    Represents number of months before conversion to floating rate.(2)
    
    48.1%
        of the loans underlying our non-agency RMBS do not conform to agency underwriting
        standards.Actual
  maturities of RMBS are generally shorter than stated contractual maturities,
  as they are affected by the contractual lives of the underlying mortgages, periodic
  payments of principal, and prepayments of principal. The stated contractual
  final maturity of the mortgage loans underlying our portfolio of RMBS ranges
  up to 30 years from date of issuance, but the expected maturity is subject to
  change based on the prepayments of the underlying loans. As of June 30, 2005
  and December 31, 2004, the average final contractual maturity of the mortgage
  portfolio is in years 2035 and 2034, respectively.
The constant prepayment rate, or CPR, attempts to predict the percentage
of principal that will prepay over the next 12 months based on historical principal paydowns. As
interest rates rise, the rate of refinancings typically declines, which we believe may result in
lower rates of prepayment and, as a result, a lower portfolio CPR.
As
  of June 30, 2005 and December 31, 2004, the mortgages underlying our hybrid
  adjustable rate RMBS had fixed interest rates an average period of approximately
  49 months and 51 months, respectively, after which time the interest rates reset
  and become adjustable. The average length of time until contractual maturity
  of those mortgages was 30 years from date of issuance.
After the reset date, interest rates on our hybrid adjustable rate
RMBS securities float based on spreads over various London  Interbank Offered Rate, or LIBOR, indices. These interest rates are subject
to caps that limit the amount the applicable interest rate can increase during any year, known as
an annual cap, and through the maturity of the applicable security, known as a lifetime cap. At June
30, 2005, the weighted average lifetime cap for the portfolio is an increase of 10.3%; the weighted
average maximum increase in the first year that the rates are adjustable is 4.1% and the
- 31 -
weighted average maximum annual increase for years subsequent to the first year is 2.2%.
The
  following table summarizes our RMBS according to their average expected life
  classifications:
June 30, 2005
    
    December 31, 2004Average Expected Life
    
    Fair
      Value
    
    Amortized
      Cost
    
    Fair
      Value
    
    Amortized
      Cost(In thousands)
    
    (In thousands)Less than one year
    
    $
    
    
    $
    
    
    $
    
    
    $
    Greater than one year and less than five years
    
    
    497,874
    
    
    502,251
    
    
    
    
    
    Greater than five years
    
    
    3,477,801
    
    
    3,489,347
    
    
    444,958
    
    
    445,413Total
    
    $
    3,975,675
    
    $
    3,991,598
    
    $
    444,958
    
    $
    445,413The
  average expected lives of the RMBS in the tables above are based upon prepayment
  models obtained through subscription-based financial information service providers.
  The prepayment model considers current yield, forward yield, steepness of the
  yield curve, current mortgage rates, the mortgage rate of the outstanding loan,
  loan age, margin and volatility. For purposes of this disclosure, average expected
  life is intended to reflect the estimated average period of time the securities
  in the portfolio will remain outstanding.
The
  actual lives of the RMBS in our investment portfolio could be longer or shorter
  than the estimates in the table above depending on the actual prepayment rates
  experienced over the lives of the applicable securities and are sensitive to
  changes in both prepayment rates and interest rates.
Asset-Backed Securities
During
  May 2005 we entered into a warehouse agreement to fund the purchase of up to
  $300 million of ABS by Pinetree CDO Ltd., or Pinetree, during the warehouse
  period. Upon review of the warehouse transaction, we determined that Pinetree
  was a VIE under FIN 46R and we were the primary beneficiary of the VIE.
  As a result, we consolidated Pinetree as of June 30, 2005, even though we did
  not own any of its equity. The ABS held in Pinetree are included in available-for-sale
  securities. We accrued interest income based on the contractual terms of the
  Pinetree ABS and accrued interest expense on the warehouse repurchase agreement
  in the condensed consolidated statement of operations.
At June 30, 2005, Pinetree held $156.8 million of ABS classified as available-for sale. The purchase of these securities was
funded via a repurchase agreement under a warehouse agreement entered into in anticipation of a Pinetree
CDO transaction. The ABS are backed primarily by residential
- 32 -
mortgages and home equity
  loans and commercial mortgages. The portfolio has a weighted average coupon
  of 5.68%, weighted average life of 5.0 years and a weighted average rating factor
  that equates to a Moodys Baa2 level.
Loans Held for Sale
At
  June 30, 2005, we held $291.6 million in bank loans held for sale. We funded
  $49.9 million directly and $241.7 million via a CDO transaction in one of our
  taxable REIT subsidiary entities, Market Square CLO Ltd., or Market Square,
  which is directly owed by Deerfield Triarc Capital LLC.
During March 2005, we entered into a warehouse agreement to fund
the purchase of up to $300 million of loans by Market Square during the warehouse period. In May
2005, Market Square repaid the warehouse liability and issued preference shares of
$24 million and several classes of notes aggregating $276 million. We purchased 100% of the preference
shares representing substantially all of the equity interest in Market Square, and thus consolidate Market Square
at June 30, 2005. The notes have a weighted average interest rate of LIBOR plus 0.49% and are secured
by the bank loan portfolio. The $241.7 million of bank loans outstanding are included in bank loans
held for sale, and the $276 million of notes payable are included in long-term debt. The weighted
average coupon spread over LIBOR on the loan portfolio was 2.65% and the weighted average maturity
was 5.5 years.
The
  bank loans that we funded directly at June 30, 2005 include first and second
  lien and mezzanine loans. These loans are carried at lower of cost or market
  value of $49.9 million, have a total market value of $50.3 million and weighted
  average interest rate of 11.10%.
Other Fixed Income Securities
At June 30, 2005, we held a synthetic CDO debt tranche of $2.7
million and a high-yield corporate bond of $2.9 million. These investments are classified as available
for sale and thus carried at fair value on our balance sheet with changes in fair value recognized
in accumulated other comprehensive income until realized.
At June 30, 2005, we held an inverse interest-only strip security,
collateralized by a residential mortgage pool, of $5.0 million. This investment is classified as
trading with changes in fair value recognized through income.
At December 31, 2004, we classified certain short-term non-real
estate related securities as held to maturity. These investments were reported at amortized cost.
All held to maturity investments have matured. As of June 30, 2005, we do not have any securities
classified as held to maturity.

- 33 -
Equity Securities
Our investment policies allow us to acquire equity securities,
including common and preferred shares issued by other real estate investment trusts. At June 30,
2005, our equity investment consisted of one common stock investment and two preferred stock investments
totaling approximately $20.1 million in fair value, or less than 1% of our total portfolio.
These investments above are classified as available for sale and
thus carried at fair value on our balance sheet with changes in fair value recognized in accumulated
other comprehensive income until realized.
At December 31, 2004, we did not hold any equity securities.
Interest Receivable
At June 30, 2005, our interest receivable of $18.6 million consisted
of $15.5 million relating to RMBS, $1.3 million relating to bank loans, and $1.8 million relating
to other investments. At December 31, 2004, interest receivable of $1.2 million consisted primarily
of purchased interest on our RMBS.
Hedging Instruments
There can be no assurance that our hedging activities will have
the desired beneficial impact on our results of operations or financial condition. Moreover, no hedging
activity can completely insulate us from the risks associated with changes in interest rates and
prepayment rates. We generally intend to hedge as much of the interest rate risk as Deerfield Capital
determines is in the best interest of our stockholders, after considering the cost of such hedging
transactions and our desire to maintain our status as a REIT. Our policies do not contain specific
requirements as to the percentages or amount of interest rate risk that our manager is required to hedge.
At June 30, 2005 and December 31, 2004, we had engaged in
interest rate swaps and interest rate swap forwards as a means of mitigating our interest rate risk
on forecasted interest expense associated with repurchase agreements for a specified future time
period, which is the term of the swap contract. An interest rate swap is a contractual agreement
entered into by two counterparties under which each agrees to make periodic payments to the other
for an agreed period of time based upon a notional amount of principal. Under the most common form
of interest rate swap, a series of payments calculated by applying a fixed rate of interest to a
notional amount of principal is exchanged for a stream of payments similarly calculated but using
a floating rate of interest. This is a fixed-floating interest rate swap. We hedge our floating rate
debt by entering into fixed floating interest rate swap agreements whereby we swap the floating rate
of interest on the liability we are hedging for a fixed rate of interest. An interest rate swap forward
is an interest rate swap based on an interest rate to be set at an agreed future date. At June 30,
2005, we entered into interest rate swaps and interest rate swap forwards with maturities ranging
from July 2006 to May 2015 with a notional amount of $2.1 billion. At December 31, 2004,
we entered into interest rate swaps and interest rate swap forwards with maturities ranging from
December 2006 to January 2008 with a notional amount of $241 million. Under the swap agreements in
place at June 30, 2005 and December 31, 2004, we receive interest at rates that reset periodically,
generally every one or three months, and pay a rate fixed at the initiation of and for the life of
the swap agreements. The current market value of interest
- 34 -
rate swaps is heavily dependent on the current market fixed rate, the corresponding term structure
of floating rates (known as the yield curve) as well as the expectation of changes in future floating
rates. As expectations of future floating rates change, the market value of interest rate swaps changes.
Based on the daily market value of those interest rate swaps and interest rate swap forward contracts,
our counterparties may request additional margin collateral or we may request additional collateral
from our counterparties to ensure that an appropriate margin account balance is maintained at all
times through the maturity of the contracts. At June 30, 2005, the unrealized gain on interest rate
swap contracts of $1.7 million consists primarily of deferred gains on terminated swaps that will
be amortized over the original hedging period. At December 31, 2004, the unrealized loss on
interest rate swap and interest rate swap forward contracts in accumulated other comprehensive income
was $(0.3) million on contracts entered into since our inception on December 23, 2004.
Liabilities
We have entered into repurchase agreements to finance some of our
purchases of RMBS. These agreements are secured by our RMBS and bear interest rates that have historically
moved in close relationship to LIBOR. As of June 30, 2005 and December 31, 2004, we had established
15 and six borrowing relationships, respectively, with various investment banking firms and other
lenders. As of June 30, 2005 and December 31, 2004, we had utilized eight and two of those relationships,
respectively.
At
  June 30, 2005 and December 31, 2004, we had outstanding $3.2 billion, including
  Pinetree described below, and $317.8 million of liabilities pursuant to
  repurchase agreements with weighted-average current borrowing rates of 3.19%
  and 2.47%, respectively. We intend to seek to renew these repurchase agreements
  as they mature under the then-applicable borrowing terms of the counterparties
  to the repurchase agreements. At June 30, 2005 and December 31, 2004, the repurchase
  agreements were secured by RMBS and other investment securities with an estimated
  fair value of $3.2 billion and $327.6 million and had weighted-average
  remaining maturities of 32 days and 59 days, respectively. The net amount at
  risk, defined as fair value of securities sold, plus accrued interest income,
  minus repurchase agreement liabilities, plus accrued interest expense, with
  all counterparties was $10.3 million and $11.0 million at June 30, 2005
  and December 31, 2004, respectively. See details of net amount at risk
  at Item 2Liquidity and Capital Resources.
During March 2005, we entered into a warehouse agreement
to fund the purchase of up to $200 million of loans by Market Square during the warehouse period.
In May 2005, Market Square repaid the warehouse liability and issued preference shares
of $24 million and several classes of notes aggregating $276 million. The notes have a weighted average
interest rate of LIBOR plus 0.49% and are secured by the bank loan portfolio. We purchased 100% of
the preference shares representing substantially all of the equity interest in Market Square, and because we consolidated
Market Square at June 30, 2005, the $276 million of notes payable are included in our consolidated
long term debt. The $24 million of preference shares are eliminated in consolidation.
During May 2005, we entered into warehouse, master repurchase and
pledge agreements with an affiliate of
- 35 -
UBS Securities LLC under
  which UBS will fund the purchase of ABS by Pinetree, a consolidated VIE, during
  the warehouse period with a current weighted average rate of 3.53% at June 30,
  2005. Pursuant to the agreement, UBS has recourse to us only for the first $12
  million in losses on the ABS portfolio. As a result of consolidating Pinetree,
  we had a repurchase agreement liability of $147.7 million at June 30, 2005,
  representing financing of ABS assets of $156.8 million described in Asset-Backed
  Securities.
At
  June 30, 2005, we had a liability for unsettled bank loans of $34.2 million
  in Market Square and unsettled mortgage securities purchases of $710.2 million
  that subsequently settled in July 2005. Of these July settlements, $300.0 million
  are related to To Be Announced, or TBA, RMBS. At December 31, 2004, we
  had unsettled mortgage securities purchases of $117.7 million that subsequently
  settled in January 2005. Of this amount, $59.8 million are related to TBA
  RMBS.
At June 30, 2005, we had dividends payable of $9.6 million
for our quarterly distribution of $0.35 per share declared on June 14, 2005 and payable on July 15,
2005 to shareholders of record on June 22, 2005.
Interest payable at June 30, 2005 of $13.1 million consists of $11.2 million net accrued interest payable on interest rate swaps, $1.5 million interest expense payable on the Market Square notes and $0.4 million accrued interest on the Pinetree repurchase agreements. There was no interest payable at December 31, 2004.
We recorded a liability at June 30, 2005 for unpaid costs incurred
in the public offering of our shares in the amount of $2.0 million, consisting primarily of printing
and legal expenses. At December 31, 2004, we recorded a liability of $857,000 for unpaid costs incurred
in our private offering of our shares.
Stockholders Equity
Stockholders equity at June 30, 2005 was $728.7 million and included $14.3 million net unrealized losses on available for sale and $1.7 million of unrealized gains on cash flow hedges, consisting primarily of deferred gains on terminated swaps that will be amortized over the original hedging period, presented as a component of accumulated other comprehensive loss. This amount reflects net proceeds of $363.5 million raised in the public offering of our shares that was declared effective by the Securities and Exchange Commission on June 28, 2005. Trading of our shares commenced on June 29, 2005 on the New York Stock Exchange under the ticker symbol DFR. At December 31, 2004 stockholders equity was $378.0 million and included $455,000 of net unrealized losses on mortgage-backed securities available-for-sale and $249,000 of net unrealized losses on derivative
instruments designated as hedges.

- 36 -

Results of Operations
For the Three Months
  Ended June 30, 2005
Summary
Our
  net income for the three months ended June 30, 2005 was $6.8 million or $0.25
  per weighted-average basic and diluted share outstanding.
Net Interest  Income
Net
  interest income for the three months ended June 30, 2005 was $10.9 million.
  Interest income of $39.3 million primarily consisted of $36.8 million in interest
  income on RMBS securities, $0.7 million in interest income on short-term investments,
  $3.2 million interest income on bank loans and $1.4 million in interest income
  on corporate debt securities, reduced by $3.1 million of RMBS purchase premium
  amortization. Interest expense of $28.4 million consisted of $22.5 million related
  to repurchase agreements, $3.4 million related to interest rate swaps, and interest
  expense on bank loans of $2.3 million, plus hedging ineffectiveness of $0.2
  million.
Net Investment Loss
Net
  investment loss for the three months ended June 30, 2005 of $0.2 million consisted
  primarily of $1.0 million realized net loss on sale of RMBS, $0.4 million realized
  loss on bank loans, $1.7 million realized gain on termination of designated
  interest rate swaps that were replaced by other swaps, $0.6 million realized
  gain on an interest rate swap not designated as part of our hedging strategy,
  $1.3 million net unrealized loss on an undesignated interest rate swap and credit
  default swaps, and $0.6 million unrealized gain on securities classified as
  trading. We recorded a loss of $0.3 million on bank loans where the fair value
  of bank loans was below cost.
Non-Investment Expenses
Non-investment
  expenses were $3.8 million for the three months ended June 30, 2005. Management
  fees of $3.0 million consist of $1.7 million base management fees payable to
  Deerfield Capital in accordance with our management agreement and $1.3 million
  of amortization related to the restricted stock and stock options granted to
  Deerfield Capital. Deerfield Capital did not earn an incentive fee during the
  quarter. Directors fees and insurance premiums expense for directors and
  officers were $0.4 million. We incurred other general and administrative expenses,
  including legal and accounting fees, of $0.4 million.
Income Tax Benefits
We
  intend to elect to be taxed as a REIT and to comply with the provisions of the
  Internal Revenue Code with respect thereto. Accordingly, we are not subject
  to federal income tax to the extent that our distributions to stockholders satisfy
  the REIT requirements and certain asset, income and ownership tests and recordkeeping
  requirements are fulfilled. We continue to make and hold most of our investments
  and conduct most of our other operations directly or through our wholly owned
  limited liability company subsidiary. Even if we qualify for exemption of federal
  taxation as a REIT, we may be subject to some amount of federal, state and local
  taxes on our taxable income. Deerfield Triarc TRS Holdings, Inc., our domestic
  taxable REIT subsidiary, is taxed as a regular subchapter C corporation under
  the provisions of the Code. Deerfield Triarc TRS Holdings, Inc. was formed to
  make, from time to time, certain investments that would not be REIT qualifying
  investments if made directly by
- 37 -
us and to earn income that would not be REIT qualifying income if earned directly by us. For the quarter
ended June 30, 2005, Deerfield Triarc TRS Holdings, Inc. had no activity and thus no taxable income.
Market
  Square is a foreign taxable REIT subsidiary that was formed to complete a securitization
  transactions structured as a secured financing transaction. It is organized
  as an exempted company incorporated with limited liability under the laws of
  the Cayman Islands, and is generally exempt from federal and state income tax
  at the corporate entity level because it restricts its activities in the United
  States to trading in stock and securities for its own account. Therefore, despite
  its status as a taxable REIT subsidiary, it generally will not be subject to
  corporate income tax on its earnings; however, we will generally be required
  to include its current taxable income in our calculation of REIT taxable income.
For the Six-Month Period Ended June 30, 2005
Summary
Our
  net income for the six months ended June 30, 2005 was $12.7 million or $0.47
  per weighted-average basic and diluted share outstanding.
Net Interest  Income
Net
  interest income for the six months ended June 30, 2005 was $19.8 million. Interest
  income of $64.5 million primarily consisted of $61.3 million in interest income
  on RMBS securities, $2.1 million in interest income on short-term investments,
  $3.6 million interest income on bank loans and $1.6 million in interest income
  on corporate debt securities reduced by $4.3 million of RMBS purchase premium
  amortization. Interest expense of $44.8 million consisted of $36.0 million related
  to repurchase agreements, $6.3 million related to interest rate swaps, and interest
  expense on bank loans of $2.5 million. The effect of hedging ineffectiveness
  netted approximately to zero for the period.
Net Investment Loss
Net
  investment loss for the six months ended June 30, 2005 of $0.3 million consisted
  of $1.0 million realized net loss on sale of RMBS, $0.3 million realized loss
  on bank loans, $1.7 million realized gain on termination of designated interest
  rate swaps that were replaced by other swaps, $0.6 million realized gain on
  an interest rate swap not designated as part of our hedging strategy, $1.3 million
  net unrealized loss on an undesignated interest rate swap and credit default
  swaps, and $0.5 million unrealized gain on securities classified as trading.
  We recorded a loss of $0.6 million on bank loans where the fair value of bank
  loans was below cost.
Non-Investment Expenses
Non-investment
  expenses were $6.7 million for the six months ended June 30, 2005. Management
  fees of $5.6 million consist of $3.4 million base management fees payable to
  Deerfield Capital in accordance with our management agreement and $2.2 million
  of amortization related to the restricted stock and stock options granted to
  Deerfield Capital.
- 38 -
Deerfield Capital did not earn an incentive fee during the period. Directors fees and insurance
premiums expense for directors and officers were $0.6 million. We incurred other general and administrative
expenses, including legal and accounting fees, of $0.5 million.
Income Tax Benefits
We
  intend to elect to be taxed as a REIT and to comply with the provisions of the
  Internal Revenue Code with respect thereto. Accordingly, we are not subject
  to federal income tax to the extent that our distributions to stockholders satisfy
  the REIT requirements and certain asset, income and ownership tests and recordkeeping
  requirements are fulfilled. We continue to make and hold most of our investments
  and conduct most of our other operations directly or through our wholly owned
  limited liability company subsidiary. Even if we qualify for exemption of federal
  taxation as a REIT, we may be subject to some amount of federal, state and local
  taxes on our taxable income. Deerfield Triarc TRS Holdings, Inc., our domestic
  taxable REIT subsidiary, is taxed as a regular subchapter C corporation under
  the provisions of the Code. Deerfield Triarc TRS Holdings, Inc. was formed to
  make, from time to time, certain investments that would not be REIT qualifying
  investments if made directly by us and to earn income that would not be REIT
  qualifying income if earned directly by us. For the six-month period ended June
  30, 2005, Deerfield Triarc TRS Holdings, Inc. had no activity and thus no taxable
  income.
Market
  Square is a foreign taxable REIT subsidiary that was formed to complete a securitization
  transaction structured as a secured financing transaction. It is organized as
  an exempted company incorporated with limited liability under the laws of the
  Cayman Islands, and is generally exempt from federal and state income tax at
  the corporate entity level because it restricts its activities in the United
  States to trading in stock and securities for its own account. Therefore, despite
  its status as a taxable REIT subsidiary, it generally will not be subject to
  corporate income tax on its earnings; however, we will generally be required
  to include its current taxable income in our calculation of REIT taxable income.
Contractual Obligations and Commitments
As
  of December 23, 2004, we had entered into a management agreement with Deerfield
  Capital. Deerfield Capital is entitled to receive a base management fee, incentive
  compensation and, in certain circumstances, a termination fee and reimbursement
  of certain expenses as described in the management agreement. Such fees and
  expenses do not have fixed and determinable payments. The base management fee
  is payable monthly in arrears in an amount equal to 1/12 of our equity (as defined
  in the management agreement) times 1.75%. Deerfield Capital uses the proceeds
  from its management fee in part to pay compensation to its officers and employees
  who, notwithstanding that certain of them also are our officers, receive no
  cash compensation directly from us. Deerfield Capital will receive quarterly
  incentive compensation in an amount equal to the product of: (a) 25% of the
  dollar amount by which (i) our net income (determined in accordance with GAAP)
  before non-cash equity compensation expense and incentive compensation, for
  the quarter per common share (based on the weighted average actual number of
  common shares outstanding for the quarter) exceeds (ii) an amount equal to (A)
  the weighted average of the price per share of the common shares in the December
  2004 private offering and our June 2005 initial public offering and the
- 39 -
prices per common shares in any subsequent offerings by us, in each case at the time of issuance thereof, multiplied by (B) the greater of (1) 2.00% and (2) 0.50% plus one-fourth of the Ten Year Treasury Rate for such quarter, multiplied by (b) the weighted average number of common shares outstanding during the quarter;provided, that the foregoing calculation of incentive compensation shall be adjusted to exclude one-time events
pursuant to changes in GAAP, as well as non-cash charges after discussion between Deerfield Capital
and our independent directors and approval by a majority of our independent directors in the case
of non-cash charges.
Off-Balance Sheet Arrangements
As of June 30, 2005 and December 31, 2004, we did not maintain
any relationships with unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance, or special purpose or variable interest entities, established
for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited
purposes. Further, as of June 30, 2005 and December 31, 2004 we had not guaranteed any obligations
of unconsolidated entities or entered into any commitment or intent to provide additional funding
to any such entities.
Liquidity and Capital Resources
We
  held cash and cash equivalents of $131.0 million and $268.7 million at June
  30, 2005 and December 31, 2004, respectively.
Our
  operating activities used cash flows of $217.9 million during the six-month
  period ended June 30, 2005 primarily through net income and proceeds from sale
  of bank loans held for sale offset by purchase of bank loans held-for-sale.
  As a result of the closing of the Market Square CLO transaction on May 10, 2005,
  we terminated the warehouse participation agreement, paid the related liability
  and acquired bank loans. During the three- and six-month periods ended June
  30, 2005, we acquired Market Square and other bank loans net of bank loan sales
  proceeds of $266.8 million and $270.2 million, respectively
Our
  investing activities used cash flows of $2.9 billion during the six-month period
  ended June 30, 2005 primarily from purchase of available-for-sale and held-to-maturity
  securities, offset by proceeds received on sale, principal payments received
  and maturities of available-for-sale and held-to-maturity securities.
Our
  financing activities provided cash flows of $3.0 billion during the six-month
  period ended June 30, 2005 primarily from net borrowings under repurchase agreements
  and issuance of Market Square debt securities.
- 40 -
Our
  source of funds, excluding our December 2004 private offering and June 2005
  initial public offering, as of June 30, 2005 and December 31, 2004 consisted
  of net proceeds from repurchase agreements totaling $3.2 billion and $317.8
  million, respectively, with a weighted-average current borrowing rate of 3.19%
  and 2.47%, respectively, which we used to finance the acquisition of mortgage-related
  assets. We expect to continue to borrow funds in the form of repurchase agreements.
  As of June 30, 2005 we had established 15 borrowing arrangements with various
  investment banking firms and other lenders, eight of which were in use on June
  30, 2005. Increases in short-term interest rates could negatively impact the
  valuation of our mortgage-related assets, which could limit our borrowing ability
  or cause our lenders to initiate margin calls. Amounts due upon maturity of
  our repurchase agreements will be funded primarily through the rollover/reissuance
  of repurchase agreements and monthly principal and interest payments received
  on our mortgage-backed securities.
The following table presents certain information regarding our
debt obligations as of June 30, 2005 and December 31, 2004:
Amount at Risk(1)
    
    Weighted-Average Maturity of 
      Repurchase Agreement in DaysRepurchase Agreement Counterparties
    
    June 30, 2005
    
    December 31, 2004
    
    June 30, 2005
    
    December 31, 2004(In thousands)Bear, Stearns & Co. Inc
    
    $
    (2,465
    )
    $
    3,793
    
    27
    
    59Cantor Fitzgerald
    
    
    190
    
    
    
    
    28Countrywide Securities Corp.
    
    
    6,927
    
    
    7,231
    
    32
    
    59Credit Suisse First Boston LLC
    
    
    592
    
    
    
    
    25Lehman Brothers Inc.
    
    
    97
    
    
    
    
    25Morgan Stanley & Co. Incorporated
    
    
    (11,337
    )
    
    
    
    25Nomura Securities International
    
    
    6,937
    
    
    
    
    54UBS Securities LLC
    
    
    9,365
    
    
    
    
    34Total
    
    $
    10,306
    
    $
    11,024(1)
    
    Equal to the fair value of securities sold, plus accrued interest income, minus repurchase agreement liabilities, plus accrued interest expense.Except as noted below, the repurchase agreements for our repurchase
facilities do not include substantive provisions other than those contained in the standard master
repurchase agreement as published by the Bond Market Association. The repurchase agreement for one
repurchase facility includes provisions that (a) limit our ability to resell or transfer bearer
debt securities issued by a non-US entity and securities that have not been registered under the
Securities Act and (b) establish an event of default upon our insolvency or our default under
- 41 -
any other agreement with the counterparty. Another repurchase facility includes provisions that establish
termination events if (a) we incur a net asset value decline of 15% on a monthly basis, 25%
on a quarterly basis and 35% on an annual basis, except that net asset value reductions resulting
from distributions are excluded in measuring such declines, (b) we fail to maintain a minimum
net asset value of $188 million, (c) Deerfield Capital ceases to be our manager, (d) we
fail to qualify as a REIT and (e) we fail to deliver certain documents, including monthly net
asset value, prospectus, performance or other reports delivered to our stockholders and an annual
representation of our president or chief financial officer. An event of default or termination event
under the standard master repurchase agreement or additional provisions explained above would give
our counterparty the option to terminate all repurchase transactions existing with us and make any
amount due by us to the counterparty to be payable immediately.
We intend to make regular quarterly distributions of all or substantially
all of our REIT taxable income to holders of our common stock. In order to maintain our qualification
as a REIT and to avoid corporate-level income tax on the income we distribute to our stockholders,
we are required to distribute at least 90% of our REIT taxable income and short-term capital gains
on an annual basis. This requirement can impact our liquidity and capital resources. On March 31,
2005, we declared a quarterly distribution of $0.225 per share of our common stock, payable April 29,
2005 to stockholders of record as of March 24, 2005. On June 14, 2005 we declared a quarterly
distribution of $0.35 per share of our common stock, payable July 15, 2005 to stockholders of record
as of June 22, 2005. We funded these distributions from uninvested cash.
For our short-term (one year or less) and long-term liquidity,
we also rely on the cash flow from operations, primarily monthly principal and interest payments
to be received on our mortgage-backed securities, as well as any primary securities offerings authorized
by our board of directors and through our match-funded CDO strategy. Our CDO strategy is dependent
upon our ability to place the match-funded debt we intend to create in the market at spreads that
provide a positive arbitrage. If spreads for CDO liabilities widen or if demand for such liabilities
ceases to exist, then our ability to execute the CDO strategy will be restricted.
Based
  on our current portfolio, leverage rate and available borrowing arrangements,
  we believe that the net proceeds of our December 2004 private offering and June
  2005 initial public offerings combined with the cash flow from operations and
  the utilization of borrowings, will be sufficient to enable us to meet anticipated
  short-term (one year or less) liquidity requirements such as to fund our investment
  activities, pay fees under our management agreement, fund our distributions
  to stockholders and for general corporate expenses. However, an increase in
  prepayment rates substantially above our expectations could cause a temporary
  liquidity shortfall due to the timing of the necessary margin calls on the financing
  arrangements and the actual receipt of the cash related to principal paydowns.
  If our cash resources are at any time insufficient to satisfy our liquidity
  requirements, we may have to sell debt or additional equity securities. If required,
  the sale of MBS at prices lower than their carrying value would result in losses
  and reduced income. As explained more fully below, we have additional capacity
  to leverage our equity further should the need for additional short term (one
  year or less) liquidity arise.
- 42 -
Our
  ability to meet our long-term (greater than one year) liquidity and capital
  resource requirements will be subject to obtaining additional debt financing
  and equity capital. We may increase our capital resources by consummating public
  offerings of equity securities, possibly including classes of preferred stock,
  common stock, commercial paper, medium-term notes, CDOs, collateralized mortgage
  obligations and senior or subordinated notes. Such financing will depend on
  market conditions for capital raises and for the investment of any proceeds.
  If we are unable to renew, replace or expand our sources of financing on substantially
  similar terms, it may have an adverse effect on our business and results of
  operations. Upon liquidation, holders of our debt securities and shares of preferred
  stock and lenders with respect to other borrowings will receive a distribution
  of our available assets prior to the holders of our common stock.
We generally seek to borrow between eight and 12 times the amount
of our equity. At June 30, 2005, our total debt was $4.2 billion, which represented a leverage
ratio of approximately six times. This leverage ratio is low at June 30, 2005 because we had not
yet applied the entire amount of capital raised in our June 2005 public offering to the RMBS portfolio.
If our leverage ratio at June 30, 2005 were 12 times our equity, our total debt would have been $8.7 billion,
which represents an additional $4.5 billion of borrowing.
Estimated REIT Taxable
  Income
Estimated
  REIT taxable income, which is a non-GAAP financial measure, is calculated according
  to the requirements of the Internal Revenue Code, rather than GAAP. The following
  table reconciles GAAP net income to estimated REIT taxable income for the three
  and six months ended June 30, 2005:
Three
      months ended
      June 30, 2005
    
    Six months ended
      June 30, 2005(in thousands)
    
    (in thousands)GAAP net income
    
    $
    6,849
    
    $
    12,746Adjustments to GAAP net income:Net tax adjustments related to organization costs
    
    
    (2
    )
    
    3Addback of hedge ineffectiveness in the period
    
    
    248
    
    
    (37
    )Net tax adjustments related to grant of restricted stock and options
    
    
    1,294
    
    
    2,246Net tax adjustments related to discount accretion and premium amortization
    
    
    84
    
    
    179Net
      unrealized loss
    
    
    1,106
    
    
    1,386Utilization of prior periods estimated taxable loss
    
    
    
    
    
    (74
    )Net adjustments to GAAP net income
    
    
    2,730
    
    
    3,703Estimated REIT taxable income
    
    $
    9,579
    
    $
    16,449- 43 -
We
  believe that the presentation of our estimated REIT taxable income is useful
  to investors because it demonstrates to investors the minimum amount of distributions
  we must make in order to maintain our qualification as a REIT and not be obligated
  to pay federal and state income taxes. However, beyond our intent to distribute
  to our stockholders at least 90% of our REIT taxable income on an annual basis
  in order to maintain our REIT qualification, we do not expect that the amount
  of distributions we make will necessarily correlate to our estimated REIT taxable
  income. Rather, we expect to determine the amount of distributions we make based
  on our cash flow and what we believe to be an appropriate and competitive dividend
  yield relative to other specialty finance companies and mortgage REITs. Estimated
  REIT taxable income will not necessarily bear any close relation to cash flow.
  Accordingly, we do not consider estimated REIT taxable income to be a reliable
  measure of our liquidity although the related distribution requirement can impact
  our liquidity and capital resources. Moreover, there are limitations associated
  with estimated REIT taxable income as a measure of our financial performance
  over any period, and our presentation of estimated REIT taxable income may not
  be comparable to similarly titled measures of other companies, who may use different
  calculations. As a result, estimated REIT taxable income should not be considered
  as a substitute for our GAAP net income as a measure of our financial performance.
Recent Developments

Initial
  Public Offering In our initial public offering, we issued 24,320,715
  shares of common stock, par value $0.001 per share, pursuant to registration
  statement no. 333-123762, which was declared effective by the Securities and
  Exchange Commission on June 28, 2005. In addition, selling stockholders identified
  in the registration statement sold an aggregate of 679,285 shares of common
  stock. Our initial public offering commenced on June 28, 2005, and closed on
  July 5, 2005. The managing underwriters for the offering were Credit Suisse
  First Boston, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, UBS
  Securities LLC and Deutsche Bank Securities Inc., who served as representatives
  on behalf of themselves and the other underwriters, which included Wachovia
  Capital Markets, LLC, Bear, Stearns & Co. Inc., Jeffries & Company,
  Inc., RBC Capital Markets Corporation and Stifel, Nicolaus & Company, Incorporated.
  All of the shares offered by us were sold by us for an aggregate amount of approximately
  $365.8 million (net of underwriting discount) and all of the shares offered
  by the selling stockholders were sold by the selling stockholders for an aggregate
  amount of approximately $10.2 million.
From
  June 28, 2005 to June 30, 2005, we incurred approximately $25.6 million in expenses
  in connection with the issuance and distribution of the registered common stock,
  including the payment of a $23.3 million underwriting discount and $2.3 million
  in other offering-related expenses. Of these expenses, $14,000 was paid to our
  directors or officers or their associates for reimbursement of expenses incurred
  prior to the closing of the offering.

- 44 -
The net proceeds from our initial public offering of common stock, after deducting the underwriting
discount and offering expenses payable by us, were approximately $363.5 million. From June 28, 2005
to June 30, 2005, we did not use any of the net offering proceeds for construction of plant, building
and facilities, for the purchase and installation of machinery and equipment or for the repayment
of indebtedness. We intend to use all of the net proceeds, together with approximately $42.5 million
cash on hand,   to repay approximately $406.0 million of outstanding indebtedness under certain repurchase agreements as follows:
Repurchase Agreement Counterparties
    
    Amount
      Outstanding
    
    Borrowing Rate
    
    Maturity
    
    Amount
      RepaidMorgan Stanley & Co. Incorporated
    
    $
    94,480,609
    
    
    3.03
    %
    
    
    7/7/2005
    
    $
    92,226,463UBS Securities LLC
    
    
    78,042,936
    
    
    3.07
    %
    
    
    7/11/2005
    
    
    72,785,954Countrywide Securities Corporation
    
    
    95,000,000
    
    
    3.16
    %
    
    
    7/22/2005
    
    
    93,357,105UBS Securities LLC
    
    
    75,049,056
    
    
    3.12
    %
    
    
    7/25/2005
    
    
    74,347,768Morgan Stanley & Co. Incorporated
    
    
    74,770,505
    
    
    3.10
    %
    
    
    7/25/2005
    
    
    73,295,576$
    417,343,106
    
    
    
    
    
    
    
    
    $
    406,012,866Portfolio Purchases  We have increased our mortgage securities portfolio throughout July. As of July 31, 2005, our
  mortgage securities portfolio is $6.5 billion and our alternative assets portfolio is $577.9 million.
Inflation
Virtually all of our assets and liabilities are interest rate sensitive
in nature. As a result, interest rates and other factors influence our performance far more so than
does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes
in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions
are determined by our board of directors based primarily by our net income as calculated for tax
purposes; in each case, our activities and balance sheet are measured with reference to historical
cost and or fair market value without considering inflation.
- 45 -
**Item 3.    Quantitative
  and Qualitative Disclosures About Market Risk**
As of June 30, 2005, the primary component of our market risk was
interest rate risk, as described below. While we do not seek to avoid risk completely, we do believe
the risk can be quantified from historical experience and seek to actively manage that risk, to earn
sufficient compensation to justify taking those risks and to maintain capital levels consistent with
the risks we undertake.
Interest Rate Risk
We are subject to interest rate risk in connection with our investments
in hybrid adjustable-rate RMBS and our related debt obligations, which are generally repurchase agreements
of limited duration that are periodically refinanced at current market rates. We mitigate this risk
through utilization of derivative contracts, primarily interest rate swap agreements.
Effect on Net Interest Income
We fund our investments in long-term, hybrid adjustable-rate RMBS
with short-term borrowings under repurchase agreements. During periods of rising interest rates,
the borrowing costs associated with those hybrid-adjustable rate RMBS tend to increase while the
income earned on such hybrid adjustable-rate RMBS (during the fixed-rate component of such securities)
may remain substantially unchanged. This results in a narrowing of the net interest spread between
the related assets and borrowings and may even result in losses.
In order to mitigate our interest rate exposure, we have entered
into 104 swap contracts as of June 30, 2005. The following table summarizes the expiration dates
of these contracts and their notional amounts (in thousands):
Expiration Date
    
    Notional AmountJuly 2006
    
    $
    22,000December 2006
    
    
    61,000January 2007
    
    
    403,900February 2007
    
    
    24,000December 2007
    
    
    32,500January 2008
    
    
    438,550February 2008
    
    
    94,300March 2008
    
    
    125,000April 2008
    
    
    346,500May 2008
    
    
    109,400June 2008
    
    
    20,000July 2008
    
    
    248,700May 2009
    
    
    7,300June 2009
    
    
    1,750April 2010
    
    
    20,000May 2010
    
    
    3,500June 2010
    
    
    5,500July 2010
    
    
    143,700May 2011
    
    
    6,400May 2014
    
    
    950May 2015
    
    
    2,750TOTAL
    
    $
    2,117,700- 46 -
Hedging techniques are partly based on assumed levels of prepayments
of our fixed-rate and hybrid adjustable-rate RMBS. If prepayments are slower or faster than assumed,
the life of the RMBS will be longer or shorter, which would reduce the effectiveness of any hedging
strategies we may use and may cause losses on such transactions. Hedging strategies involving the
use of derivative securities are highly complex and may produce volatile returns.
Extension Risk
We
  invest in hybrid adjustable-rate RMBS, which have interest rates that are fixed
  for the first few years of the loan (typically three, five, seven or 10 years)
  and thereafter reset periodically on the same basis as adjustable-rate RMBS.
  We compute the projected weighted-average life of our hybrid adjustable-rate
  RMBS based on assumptions regarding the rate at which the borrowers will prepay
  the underlying mortgages. In general, when a fixed-rate or hybrid adjustable-rate
  residential mortgage-backed security is acquired with borrowings, we may, but
  are not required to, enter into an interest rate swap agreement or other hedging
  instrument that effectively fixes our borrowing costs for a period close to
  the anticipated weighted-average life of the fixed-rate portion of the related
  RMBS. This strategy is designed to protect us from rising interest rates because
  the borrowing costs are not fixed for the duration of the fixed-rate portion
  of the related residential mortgage-backed security.
We have structured our swaps to roll off or expire in conjunction
with the estimated weighted average life of the fixed period of the mortgage portfolio. However,
if prepayment rates decrease in a rising interest rate environment, the weighted average life of
the fixed-rate portion of the related RMBS could extend beyond the term of the swap agreement or
other hedging instrument. This could have a negative impact on our results from operations, as borrowing
costs would no longer be fixed after the end of the hedging instrument while the income earned on
the remaining hybrid adjustable-rate RMBS would remain fixed for a period of time. This situation
may also cause the market value of our hybrid adjustable-rate RMBS to decline, with little or no
offsetting gain from the related hedging transactions. In extreme situations, we may be forced to
sell assets to maintain adequate liquidity, which could cause us to incur losses.
- 47 -

Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk
We also invest in hybrid adjustable-rate RMBS which are based on
mortgages that are typically subject to periodic and lifetime interest rate caps and floors, which
limit the amount by which the securitys interest yield may change during any given period.
However, our borrowing costs pursuant to our repurchase agreements will not be subject to similar
restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings
could increase without limitation by caps, while the interest-rate yields on our hybrid adjustable-rate
RMBS would effectively be limited by caps. This problem will be magnified to the extent we acquire
hybrid adjustable-rate RMBS that are not based on mortgages which are fully indexed. In addition,
the underlying mortgages may be subject to periodic payment caps that result in some portion of the
interest being deferred and added to the principal outstanding. This could result in our receipt
of less cash income on our hybrid adjustable-rate RMBS than we need in order to pay the interest
cost on our related borrowings. These factors could lower our net interest income or cause a net
loss during periods of rising interest rates, which would harm our financial condition, cash flows
and results of operations.
Interest Rate Mismatch Risk
We intend to fund a substantial portion of our acquisitions of
hybrid adjustable-rate RMBS with borrowings that, after the effect of hedging, have interest rates
based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest
rate indices and repricing terms of the RMBS. Thus, we anticipate that in most cases the interest
rate indices and repricing terms of our mortgage assets and our funding sources will not be identical,
thereby creating an interest rate mismatch between assets and liabilities. Therefore, our cost of
funds would likely rise or fall more quickly than would our earnings rate on assets. During periods
of changing interest rates, such interest rate mismatches could negatively impact our financial condition,
cash flows and results of operations. To mitigate interest rate mismatches, we may utilize hedging
strategies discussed above.
Our
  analysis of risks is based on managements experience, estimates, models
  and assumptions. These analyses rely on models which utilize estimates of fair
  value and interest rate sensitivity. Actual economic conditions or implementation
  of investment decisions by our management may produce results that differ significantly
  from the estimates and assumptions used in our models and the projected results
  reflected herein.
Prepayment Risk
Prepayments are the full or partial repayment of principal prior
to the original term to maturity of a mortgage loan and typically occur due to refinancing of mortgage
loans. Prepayment rates for existing RMBS generally increase when prevailing interest rates fall
below the market rate existing when the underlying mortgages were originated. In addition, prepayment
rates on adjustable-rate and hybrid adjustable-rate RMBS generally increase when the difference between
long-term and short-term interest rates declines or becomes negative. Prepayments
- 48 -
of RMBS could harm our results of operations in several ways. Some adjustable-rate mortgages underlying
our adjustable-rate RMBS may bear initial teaser interest rates that are lower than their fully-indexed
rates, which refers to the applicable index rates plus a margin. In the event that such an adjustable-rate
mortgage is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, the holder
of the related residential mortgage-backed security would have held such security while it was less
profitable and lost the opportunity to receive interest at the fully-indexed rate over the expected
life of the adjustable-rate residential mortgage-backed security. Although we currently do not own
any adjustable-rate RMBS with teaser rates, we may obtain some in the future which would expose us
to this prepayment risk. Additionally, we currently own RMBS that were purchased at a premium. The
prepayment of such RMBS at a rate faster than anticipated would result in a write-off of any remaining
capitalized premium amount and a consequent reduction of our net interest income by such amount.
Finally, in the event that we are unable to acquire new RMBS to replace the prepaid RMBS, our financial
condition, cash flow and results of operations could be negatively impacted.
Effect on Fair Value
Another component of interest rate risk is the effect changes in
interest rates will have on the market value of our assets. We face the risk that the market value
of our assets will increase or decrease at different rates than that of our liabilities, including
our hedging instruments.
We primarily assess our interest rate risk by estimating the duration
of our assets and the duration of our liabilities. Duration essentially measures the market price
volatility of financial instruments as interest rates change. We generally calculate duration using
various third-party financial models and empirical data. Different models and methodologies can produce
different duration numbers for the same securities.
The following sensitivity analysis table shows the estimated impact
on the fair value of our RMBS interest rate-sensitive investments and repurchase agreement liabilities,
at June 30, 2005, assuming rates instantaneously fall 100 basis points and rise 100 basis points:
Interest Rates
      Fall 100
      Basis Points
    
    Unchanged
    
    Interest Rates
      Rise 100
      Basis Points(dollars in thousands)Hybrid Adjustable-Rate RMBSFair value
    $
    4,023,426
    
    $
    3,975,675
    
    $
    3,889,195Change in fair value
    $
    47,751
    
    
    
    
    $
    (86,480
    )Change as a percent of fair value
    
    1.19
    %
    
    
    
    
    -2.22
    %Repurchase Agreements(1)Fair value
    $
    3,222,986
    
    $
    3,222,986
    
    $
    3,222,986Change in fair valueChange as a percent of fair valueDesignated and undesignated interest rate swapsFair value
    $
    (51,551
    )
    $
    483
    
    $
    50,862Change in fair value
    $
    (52,034
    )
    
    
    
    $
    50,379Change as a percent of fair value
    
    n/m
    
    
    
    
    
    n/m(1)
    
    The fair value of the repurchase agreements would not change materially due to the short-term nature of these instruments.n/m =
    
    not meaningful- 49 -
It is important to note that the impact of changing interest rates
on fair value can change significantly when interest rates change beyond 100 basis points from current
levels. Therefore, the volatility in the fair value of our assets could increase significantly when
interest rates change beyond 100 basis points. In addition, other factors impact the fair value of
our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve,
market expectations as to future interest rate changes and other market conditions. Accordingly,
in the event of changes in actual interest rates, the change in the fair value of our assets would
likely differ from that shown above, and such difference might be material and adverse to our stockholders.
At June 30, 2005, substantially all investments in our alternative investments
portfolio (non-MBS) are instruments with variable interest rates that are indexed to LIBOR. Because
the variable rates on these instruments are short term in nature, we are not subject to material
exposure to movements in fair value as a result of changes in interest rates.
Risk Management
To the extent consistent with maintaining our REIT status, we seek
to manage our interest rate risk exposure to protect our portfolio of RMBS and other mortgage securities
and related debt against the effects of major interest rate changes. We generally seek to manage
our interest rate risk by:

    monitoring
        and adjusting, if necessary, the reset index and interest rate related
        to our MBS and our borrowings;
    attempting
        to structure our borrowing agreements to have a range of different maturities,
        terms, amortizations and interest rate adjustment periods;
    using
        derivatives, financial futures, swaps, options, caps, floors 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.- 50 -
Item 4.    Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Pursuant
  to Rule 13a-15(b) under the Securities Exchange Act of 1934, the Company
  carried out an evaluation, with the participation of the Companys management,
  including the Companys Chief Executive Officer and Senior Vice President,
  Chief Financial Officer and Treasurer, of the effectiveness of the Companys
  disclosure controls and procedures (as defined under Rule 13a-15(e) under the
  Securities Exchange Act of 1934, as amended (the Exchange Act))
  as of the end of the period covered by this report. Based upon that evaluation,
  the Companys Chief Executive Officer and Senior Vice President, Chief
  Financial Officer and Treasurer concluded that the Companys disclosure
  controls and procedures are effective.
Change in Internal Control Over Financial Reporting
No change in our internal control over financial reporting was made during
our most recent fiscal quarter that materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
There are inherent limitations in the effectiveness of any control system,
including the potential for human error and the circumvention or overriding of the controls and procedures.
Additionally, judgments in decision-making can be faulty and breakdowns can occur because of simple
error or mistake. An effective control system can provide only reasonable, not absolute, assurance
that the control objectives of the system are adequately met. Accordingly, our management, including
our Chief Executive Officer and our Senior Vice President and Chief Financial Officer, does not expect
that our control system can prevent or detect all error or fraud. Finally, projections of any evaluation
or assessment of effectiveness of a control system to future periods are subject to the risks that,
over time, controls may become inadequate because of changes in an entitys operating environment
or deterioration in the degree of compliance with policies or procedures.
- 51 -
1.1.1.A PART  II. OTHER INFORMATION
Item 1.     Legal Proceedings.
None.
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds
(a) Unregistered Sales of Equity Securities. On May 24, 2005, the Company granted to each of Messrs. Howard Rubin, Robert E. Fisher, Robert B.
Machinist and Peter H. Rothschild 3,000 shares, or an aggregate of 12,000 shares, of restricted common
stock under the 2004 Stock Incentive Plan of the Company, which shares vested on the date of grant.
Such grants were exempt from the registration requirements of the Securities Act pursuant to Section
4(2) thereof.
(b)
  Use of Proceeds. See discussion under Part I, Item 2--Recent Developments--Initial
  Public Offering on pages 44-45.
Item 3.     Defaults Upon Senior Securities
None.
Item 4.     Submission of Matters to a Vote of Security Holders
The
annual meeting of stockholders of the Company was held on May 24, 2005.
Proposal
1: Stockholders elected three directors, Nelson Peltz, Robert E. Fischer and Peter H. Rothschild,
for three-year terms that will expire at the annual meeting of stockholders in 2008 or until their
successors are elected and qualified. The vote tabulation for each director was as follows:
Nominee
    Affirmative Votes
    
    Withheld Votes
    
    Abstentions
    
    Broker Non-VotesNelson Peltz
    
    23,681,929
    
    
    0
    
    
    0
    
    
    0Robert E. Fischer
    
    23,681,929
    
    
    0
    
    
    0
    
    
    0Peter H. Rothschild
    
    23,681,929
    
    
    0
    
    
    0
    
    
    0The term of office for the following directors continued after the annual meeting and such directors
were not up for election at the annual meeting:
Gregory H. SachsJonathan W. TrutterRobert B. MachinistHoward Rubin
Proposal
2: Stockholders ratified the Audit Committees selection of Deloitte Touche LLP as the
Companys independent registered public accounting firm for the fiscal year ending December
31, 2005, with 23,681,929 affirmative votes and no negative votes, abstentions, or broker non-votes.
Item 5.     Other Information
In
order to assist us in complying with the limitations on the concentration of ownership of REIT shares
imposed by the Internal Revenue Code, our charter generally prohibits any stockholder from beneficially
or constructively owning, applying certain attribution rules under the Internal Revenue Code, more
than 4.1% in value or in number of shares, whichever is more restrictive, of any class or series
of our capital stock, other than Ross Financial Corporation, which was initially permitted to own
no more than 32.46% in value or in number of shares, whichever is more restrictive, of our common
stock, and W.A. Dart Foundation, which is under common control with Ross Financial Corporation and
was initially permitted to own no more than 5.05% in value or in number of shares, whichever is more
restrictive, of our common stock. Our board may, in its sole discretion, waive the 4.1% ownership
limit with respect to a particular stockholder if it is presented with evidence satisfactory to it
that such ownership will not then or in the future jeopardize our qualification as a REIT. Our board
of directors has exempted Triarc Companies, Inc. and its affiliates (including
- 52 -
its indirect subsidiary and our manager, Deerfield Capital Management LLC) and Deutsche Bank AG from
the 4.1% limit. The special ownership limits for Ross Financial Corporation and W.A. Dart Foundation
and the ownership limit waiver for Deutsche Bank AG were granted to facilitate the closing of our
December 2004 private offering. We granted the ownership limit waiver to Triarc and its affiliates
so we could provide incentive compensation to Deerfield Capital in the form of restricted stock and
stock options and could compensate Deerfield Capital under the management agreement with common stock
without causing Triarc and its affiliates to violate the 4.1% ownership limit. Our board has the
discretion to decrease the ownership limits for Ross Financial Corporation and W.A. Dart Foundation
and to increase the ownership limits for our other investors if Ross Financial Corporation or W.A.
Dart Foundation own less than a specified percentage of our common stock. Since Ross Financial Corporation
and W.A. Dart Foundation owned less than the specified percentage following our July 2005 initial
public offering, on August 11, 2005, our board decreased the ownership limit for Ross Financial Corporation
to 16.89% and increased the ownership limit for our other stockholders (including W.A. Dart Foundation)
from 4.1% to 8.1%.
Item 6.     Exhibits
3.1
    Articles of Amendment and Restatement of Deerfield Triarc Capital Corp.*3.2
    Bylaws of Deerfield Triarc Capital Corp.*4.1
    Form of Certificate for Common Stock for Deerfield Triarc Capital Corp.*10.1
    Registration Rights Agreement among Deerfield Triarc Capital Corp., Credit Suisse First Boston LLC, Deutsche Bank Securities Inc. and Bear, Stearns & Co. Inc. for the benefit of certain holders of the common stock of Deerfield Triarc Capital Corp., dated as of December 23, 2004*10.2
    Management Agreement between Deerfield Triarc Capital Corp. and Deerfield Capital Management LLC, dated as of December 23, 2004*10.3
    License Agreement between Deerfield Triarc Capital Corp. and Deerfield Capital Management LLC, dated as of December 23, 2004*10.4
    2004 Stock Incentive Plan*10.5
    Amended and Restated Stock Award Agreement between Deerfield Triarc Capital Corp. and Deerfield Capital Management LLC, dated June 14, 2005*10.6
    Amended and Restated Stock Option Agreement between Deerfield Triarc Capital Corp. and Deerfield Capital Management LLC, dated June 14, 2005*10.7
    Form of Stock Award Agreement for Non-Employee Directors*31.1
    Certification 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 by Jonathan W. Trutter31.2
    Certification 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 by Robert E. Armour32.1
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Jonathan W. Trutter32.2
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Robert E. Armour*  Incorporated by Reference to the Companys Registration Statement on Form S-11 (Registration No. 333-123762), as amended.- 53 -

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

DEERFIELD TRIARC CAPITAL CORP.
      (Registrant)Date:
      August 15, 2005
    
    By: /S/ JONATHAN W. TRUTTERJonathan W. Trutter
      Chief Executive Officer
      (On behalf of the Company)Date:
      August 15, 2005
    
    By: /S/ ROBERT E. ARMOURRobert E. Armour
      Senior Vice President and Chief Financial Officer
      (Principal Financial and Accounting Officer)- 54 -