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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2008
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number: 1-32551
 DEERFIELD CAPITAL CORP.
  Maryland
    
    20-2008622(State of incorporation)
    
    (I.R.S. Employer
Identification No.)
 6250 North River Road, 9th Floor, Rosemont, Illinois 60018
(773) 380-1600
 þ o
  Large accelerated filer
þ
    
    Accelerated filer
o
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
 o þ




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##### 



DEERFIELD CAPITAL CORP.
2008 QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2008
INDEX
 PagePart I.
    
    Financial InformationItem 1.
    
    Condensed Consolidated Financial Statements and Notes (Unaudited)Condensed Consolidated Balance Sheets  March 31, 2008 and December 31, 2007
    
    
    5Condensed Consolidated Statements of Operations  Three Months Ended March 31, 2008 and 2007
    
    
    6Condensed Consolidated Statement of Stockholders Equity  Three Months Ended March 31, 2008
    
    
    7Condensed Consolidated Statements of Cash Flows  Three Months Ended March 31, 2008 and 2007
    
    
    8Notes to Condensed Consolidated Financial Statements
    
    
    10Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    31Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    64Item 4.
    
    Controls and Procedures
    
    
    67Part II.
    
    Other InformationItem 1A.
    
    Risk Factors
    
    
    67Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    69Item 6.
    
    Exhibits
    
    
    69Signatures
    
    
    70EX-10.1 SUPPLEMENTAL INDENTUREEX-10.2 SUPPLEMENTAL INDENTUREEX-10.3 SUPPLEMENTAL INDENTUREEX-10.4 FORBEARANCE AGREEMENTEX-10.5 OMNIBUS AMENDMENT NO. 1 TO SALE AND SERVICING AGREEMENTEX-10.6 AMENDMENT NO. 1, TO THE NOTE PURHCASE AGREEMENTEX-10.7 AMENDMENT NO. 1 TO THE NOTE PURCHASE AGREEMENTEX-31.1 SECTION 302 CERTIFICATION OF PEOEX-31.2 SECTION 302 CERTIFICATION OF PFOEX-32.1 SECTION 906 CERTIFICATION OF PEO AND PFO
  2




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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
  
 I  Item 2. Managements
Discussion and Analysis of Financial Condition and Results of Operations Part II  Item 1A.
Risk Factors Part I  Item 1A. Risk Factors Part II  Item 7. Managements
Discussion and Analysis of Financial Conditions and Results of Operations
  Relating to our business generally:
 
    
    Actual financial results may be different than any projections or estimates;
    
    effects of the current dislocation in the subprime mortgage sector and the weakness in
the mortgage market and credit markets generally;
    
    rapid changes in market value of residential mortgage-backed securities (RMBS) and
other assets, making it difficult for us to maintain our REIT qualification or our current
or any alternative exemption from the Investment Company Act of 1940, as amended (the 1940
Act);
    
    failure to comply with covenants contained in the agreements governing our indebtedness;
    
    limitations and restrictions contained in instruments and agreements governing our
indebtedness;
    
    ability to maintain adequate liquidity, including ability to raise additional capital
and secure additional financing;
    
    changes in the general economy or debt markets in which we invest;
    
    increases in borrowing costs relative to interest received on assets;
    
    the costs and effects of the current Securities and Exchange Commission (SEC)
investigation into certain mortgage securities trading procedures in connection with which
the SEC has requested information from Deerfield Capital Corp. (DFR) and Deerfield
Capital Management LLC (DCM) regarding certain of our mortgage securities trades;
    
    changes in investment strategy;
    
    ability to continue to issue collateralized debt obligation (CDO) vehicles, which can
provide us with attractive financing for debt securities investments;
    
    effects of CDO financings on cash flows;
    
    loss of key personnel, most of whom are not bound by employment agreements;
    
    adverse changes in accounting principles, tax law, or legal/regulatory requirements;
    
    changes in REIT qualification requirements, making it difficult for us to conduct our
investment strategy, and failure to maintain our qualification as a REIT;
    
    failure to comply with applicable laws and regulations;
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
    
    liability resulting from actual or potential future litigation;
    
    the costs, uncertainties and other effects of legal and administrative proceedings;
    
    the impact of competition; and
    
    actions of domestic and foreign governments and the effect of war or terrorist activity.
 Relating to the Principal Investing segment:
 
    
    impact of changes in our strategy surrounding the composition of its investment
portfolio;
    
    widening of mortgage spreads relative to swaps or treasuries leading to a decrease in
the value of our mortgage portfolio resulting in higher counterparty margin calls and
decreased liquidity;
    
    effects of leverage and indebtedness on portfolio performance;
    
    effects of defaults or terminations under repurchase transactions, interest rate swaps
and long-term debt obligations;
    
    higher or lower than expected prepayment rates on the mortgages underlying our RMBS
portfolio;
    
    illiquid nature of certain of the assets in the investment portfolio;
    
    increased rates of default on our investment portfolio (which risk rises as the
portfolio seasons) and decreased recovery rates on defaulted loans;
    
    our inability to obtain favorable interest rates, margin or other terms on the financing
that is needed to leverage our RMBS and other positions;
    
    flattening or inversion of the yield curve (short term interest rates increasing at a
greater rate than longer term rates), reducing our net interest income on its financed
mortgage securities positions;
    
    our inability to adequately hedge our holdings sensitive to changes in interest rates;
    
    narrowing of credit spreads, thus decreasing our net interest income on future credit
investments (such as bank loans);
    
    concentration of investment portfolio in adjustable-rate RMBS;
    
    effects of investing in equity and mezzanine securities of CDOs; and
    
    effects of investing in the debt of middle market companies.
 Relating to the Investment Management segment:
 
    
    significant reductions in assets under management (AUM), which would reduce our
investment advisory fee revenue, due to such factors as weak investment performance,
substantial illiquidity or price volatility in the fixed income instruments in which we
trade, loss of key portfolio management or other personnel (or lack of availability of
additional key personnel if needed for expansion), reduced investor demand for the types of
investment products that we offer or loss of investor confidence due to weak investment
performance, volatility of returns and adverse publicity;
    
    significant reductions in our AUM resulting from redemption of investment fund
investments by investors therein or withdrawal of money from separately managed accounts;
    
    significant reductions in investment advisory fees and/or AUM resulting from the failure
to satisfy certain structural protections and/or the triggering of events of default
contained in the indentures governing the CDOs;
    
    non-renewal or early termination of investment management agreements or removal of DCM
as investment manager pursuant to the terms of such investment management agreements;
    
    pricing pressure on the fees that we can charge for our investment advisory services;
    
    difficulty in increasing AUM, or efficiently managing existing assets, due to
market-related constraints on trading capacity, inability to hire the necessary additional
personnel or lack of potentially profitable trading opportunities;
    
    the reduction in CDO management fees or AUM resulting from payment defaults by issuers
of the underlying collateral, downgrades of the underling collateral or depressed market
values of the underlying collateral, all of which may contribute to the triggering of
certain structural protections built into CDOs;
    
    changes in CDO asset and liability spreads making it difficult or impossible to launch
new CDOs;
    
    our dependence on third party distribution channels to market CDOs;
    
    liability relating to our failure to comply with investment guidelines set by our
clients or the provisions of the management and other agreements; and
    
    changes in laws, regulations or government policies affecting our business, including
investment management regulations and accounting standards.
 Relating to the Merger:
 
    
    DFRs ability to integrate the businesses of DFR and DCM successfully and the amount of
time and expense to be spent and incurred in connection with the integration;
    
    the ability to realize the economic benefits that DFR anticipates as a result of the
Merger;
    
    failure to uncover all risks and liabilities associated with acquiring DCM;
    
    federal income tax liability as a result of owning DCM through taxable REIT
subsidiaries, or TRSs, and the effect of DFRs acquisition of DCM on DFRs ability to
continue to qualify as a REIT;
    
    the impact of owning DCM on DFRs ability to rely on an exemption from registration
under the 1940 Act;
    
    the limitations or restrictions imposed on DCMs investment management services as a
result of DFRs ownership of DCM;
    
    the impact of approximately $74 million of two series of senior secured notes issued as
partial consideration for the Merger and DFRs guarantee of those notes, including the
impact of DFRs guarantee of those notes on DFRs liquidity, ability to raise additional
capital and financial condition;
    
    the impact of the recent conversion into common stock of 14,999,992 shares of Series A
Preferred Stock issued in connection with the Merger, which could have a dilutive effect on
DFRs common stock and may reduce its market price; and
    
    the impact of owning DCM on DFRs ability to implement certain alternative
organizational structures.
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Part I. FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 March 31,
    
    
    December 31,2008
    
    
    2007(In thousands, except shareand per share amounts)ASSETSCash and cash equivalents
    
    $
    23,577
    
    
    $
    113,733Due from broker
    
    
    32,012
    
    
    
    270,630Restricted cash and cash equivalents
    
    
    57,141
    
    
    
    47,125Available-for-sale securities, including $2,147 and $4,884,023 pledgedat fair value
    
    
    9,935
    
    
    
    4,897,972Trading securities, including $1,442,372 and $733,782 pledgedat fair value
    
    
    1,469,742
    
    
    
    1,444,505Other investments
    
    
    5,472
    
    
    
    5,472Derivative assets
    
    
    1,221
    
    
    
    4,537Loans held for sale
    
    
    246,548
    
    
    
    267,335Loans
    
    
    427,903
    
    
    
    466,360Allowance for loan losses
    
    
    (7,500
    )
    
    
    (5,300
    )Loans, net of allowance for loan losses
    
    
    420,403
    
    
    
    461,060Investment advisory fee receivables
    
    
    4,927
    
    
    
    6,409Interest receivable
    
    
    10,645
    
    
    
    39,216Other receivable
    
    
    5,592
    
    
    
    22,912Prepaid and other assets
    
    
    15,517
    
    
    
    14,721Deferred tax asset, net
    
    
    11,814
    
    
    
    Fixed assets, net
    
    
    10,120
    
    
    
    10,447Intangible assets, net
    
    
    72,933
    
    
    
    83,225Goodwill
    
    
    78,703
    
    
    
    98,670TOTAL ASSETS
    
    $
    2,476,302
    
    
    $
    7,787,969LIABILITIESRepurchase agreements, including $1,064 and $20,528 of accrued interest
    
    $
    1,423,873
    
    
    $
    5,303,865Due to broker
    
    
    3,192
    
    
    
    879,215Dividends payable
    
    
    1,667
    
    
    
    21,944Derivative liabilities
    
    
    17,449
    
    
    
    156,813Interest payable
    
    
    6,475
    
    
    
    28,683Accrued and other liabilities
    
    
    26,723
    
    
    
    35,652Short term debt
    
    
    1,063
    
    
    
    1,693Long term debt
    
    
    778,466
    
    
    
    775,368TOTAL LIABILITIES
    
    
    2,258,908
    
    
    
    7,203,233Series A cumulative convertible preferred stock; $0.001 par value, zero shares and
14,999,992
shares issued and outstanding (aggregate liquidation value of zero and $150,000)
    
    
    
    
    
    
    116,162STOCKHOLDERS EQUITYPreferred stock, par value $0.001:100,000,000 shares authorized; zero and 14,999,992 shares issued and outstanding
    
    
    
    
    
    
    as described aboveCommon stock, par value $0.001:500,000,000
shares authorized; 66,758,356 and 51,752,720 shares issued and
66,693,418 and 51,752,720 shares outstanding
    
    
    67
    
    
    
    51Additional paid-in capital
    
    
    865,809
    
    
    
    748,216Accumulated other comprehensive loss
    
    
    (3,876
    )
    
    
    (83,783
    )Accumulated deficit
    
    
    (644,606
    )
    
    
    (195,910
    )TOTAL STOCKHOLDERS EQUITY
    
    
    217,394
    
    
    
    468,574TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    2,476,302
    
    
    $
    7,787,969
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three months ended March 31,2008
    
    
    2007(In thousands, except share and per share amounts)RevenuesInterest income
    
    $
    61,350
    
    
    $
    122,699Interest expense
    
    
    47,600
    
    
    
    98,859Net interest income
    
    
    13,750
    
    
    
    23,840Provision for loan losses
    
    
    2,200
    
    
    
    1,800Net interest income after provision for loan losses
    
    
    11,550
    
    
    
    22,040Investment advisory fees
    
    
    12,119
    
    
    
    Total net revenues
    
    
    23,669
    
    
    
    22,040ExpensesManagement fee expense to related party
    
    
    
    
    
    
    3,330Incentive fee expense to related party
    
    
    
    
    
    
    2,185Compensation and benefits
    
    
    9,358
    
    
    
    Depreciation and amortization
    
    
    2,687
    
    
    
    Professional services
    
    
    1,387
    
    
    
    617Insurance expense
    
    
    734
    
    
    
    136Other general and administrative expenses
    
    
    2,051
    
    
    
    369Impairment of intangible assets and goodwill
    
    
    27,906
    
    
    
    Total expenses
    
    
    44,123
    
    
    
    6,637Other Income and Gain (Loss)Net gain on available-for-sale securities
    
    
    
    
    
    
    2,549Net (loss) gain on trading securities
    
    
    (200,719
    )
    
    
    2,640Net (loss) gain on loans and loans held for sale
    
    
    (26,542
    )
    
    
    1,962Net (loss) gain on derivatives
    
    
    (223,215
    )
    
    
    46Dividend income and other net gain
    
    
    118
    
    
    
    264Net other income and (loss) gain
    
    
    (450,358
    )
    
    
    7,461(Loss) income before income tax (benefit) expense
    
    
    (470,812
    )
    
    
    22,864Income tax (benefit) expense
    
    
    (7,202
    )
    
    
    337Net (loss) income
    
    $
    (463,610
    )
    
    $
    22,527NET (LOSS) INCOME PER SHARE  BASIC
    
    $
    (8.43
    )
    
    $
    0.44NET (LOSS) INCOME PER SHARE  DILUTED
    
    $
    (8.43
    )
    
    $
    0.44WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING  BASIC
    
    
    54,965,218
    
    
    
    51,587,293WEIGHTED-AVERAGE NUMBER OF SHARES
OUTSTANDING  DILUTED
    
    
    54,965,218
    
    
    
    51,763,464
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (UNAUDITED)
 AccumulatedCommon Stock
    
    
    Additional
    
    
    OtherPar
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Accumulated
    
    
    
    
    
    
    ComprehensiveShares
    
    
    Value
    
    
    Capital
    
    
    Loss
    
    
    Deficit
    
    
    Total
    
    
    Loss(In thousands)Balance  December 31, 2007
    
    
    51,655
    
    
    $
    51
    
    
    $
    748,216
    
    
    $
    (83,783
    )
    
    $
    (195,910
    )
    
    $
    468,574Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (463,610
    )
    
    
    (463,610
    )
    
    $
    (463,610
    )Cumulative effect adjustment from the
adoption of SFAS No.159
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,914
    )
    
    
    14,914
    
    
    
    Available-for-sale securities  fair value adjustment
net of reclassification adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,111
    )
    
    
    
    
    
    
    (2,111
    )
    
    
    (2,111
    )Previously designated derivatives  amorization
of net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    96,904
    
    
    
    
    
    
    
    96,904
    
    
    
    96,904Foreign currency translation gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    
    
    
    
    28
    
    
    
    28Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (368,789
    )Conversion of Series A cumulative convertible preferred stock
into common stock
    
    
    15,000
    
    
    
    15
    
    
    
    117,082
    
    
    
    
    
    
    
    
    
    
    
    117,097Share-based compensation
    
    
    38
    
    
    
    1
    
    
    
    2,904
    
    
    
    
    
    
    
    
    
    
    
    2,905Preferred stock dividend and accretion
    
    
    
    
    
    
    
    
    
    
    (2,393
    )
    
    
    
    
    
    
    
    
    
    
    (2,393
    )Balance  March 31, 2008
    
    
    66,693
    
    
    $
    67
    
    
    $
    865,809
    
    
    $
    (3,876
    )
    
    $
    (644,606
    )
    
    $
    217,394
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Three months ended March 31,2008
    
    
    2007(In thousands)CASH FLOWS FROM OPERATING ACTIVITIES:Net (loss) income
    
    $
    (463,610
    )
    
    $
    22,527Adjustments to reconcile net (loss) income to net cash used in operating activities:Net premium and discount amortization on investments, loans and debt issuance costs
    
    
    393
    
    
    
    7,394Share-based compensation
    
    
    115
    
    
    
    31Hedge ineffectiveness
    
    
    
    
    
    
    (21
    )Net
purchases of trading securities
    
    
    (341,181
    )
    
    
    (184,532
    )Net loss (gain) from trading securities
    
    
    200,720
    
    
    
    (2,640
    )Other-than-temporary impairment on available-for-sale securities
    
    
    
    
    
    
    202Net gain on other investments
    
    
    
    
    
    
    (187
    )Net purchases of loans held for sale
    
    
    (1,919
    )
    
    
    (36,573
    )Net loss (gain) on loans and loans held for sale
    
    
    26,550
    
    
    
    (1,492
    )Provision for loan losses
    
    
    2,200
    
    
    
    1,800Net realized gain on available-for-sale securities
    
    
    
    
    
    
    (2,751
    )Net changes in undesignated derivatives
    
    
    (148,727
    )
    
    
    554Amortization of net loss (gain) on previously designated derivatives
    
    
    96,904
    
    
    
    (4,889
    )Net cash paid on terminated designated derivatives
    
    
    
    
    
    
    (3,588
    )Depreciation and amortization
    
    
    2,687
    
    
    
    Impairment of intangible assets and goodwill
    
    
    27,906
    
    
    
    Non-cash rental expense
    
    
    50
    
    
    
    Deferred tax benefit
    
    
    (11,814
    )
    
    
    Changes in operating assets and liabilities:Due from broker
    
    
    78,982
    
    
    
    (327,974
    )Interest receivable
    
    
    25,670
    
    
    
    (538
    )Other receivable
    
    
    904
    
    
    
    522Prepaid and other assets
    
    
    (2,803
    )
    
    
    (476
    )Accrued interest on repurchase agreements
    
    
    (19,464
    )
    
    
    (1,462
    )Due to broker
    
    
    (621
    )
    
    
    348,262Interest payable
    
    
    (7,221
    )
    
    
    2,053Management and incentive fee payable to related party
    
    
    
    
    
    
    2,207Accrued and other liabilities
    
    
    (4,242
    )
    
    
    (1,707
    )Net cash used in operating activities
    
    
    (538,521
    )
    
    
    (183,278
    )CASH FLOWS FROM INVESTING ACTIVITIES:Change in restricted cash and cash equivalents
    
    
    (10,016
    )
    
    
    (6,722
    )Purchase of available-for-sale securities
    
    
    (1,750
    )
    
    
    (1,040,472
    )Proceeds from the sale of available-for-sale securities
    
    
    
    
    
    
    612,401Principal payments on available-for-sale securities
    
    
    22,824
    
    
    
    356,890Proceeds
from the sale of trading securities previously classified as
available-for-sale
    
    
    4,138,198
    
    
    
    Principal
payments on trading securities previously classified as
available-for-sale
    
    
    144,017
    
    
    
    Origination and purchase of loans
    
    
    (1,512
    )
    
    
    (58,998
    )Principal payments on loans
    
    
    18,104
    
    
    
    39,119Proceeds from sale of loans
    
    
    18,707
    
    
    
    Purchase of fixed assets
    
    
    (8
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    4,328,564
    
    
    
    (97,782
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net (payments) borrowings under repurchase agreements
    
    
    (3,860,528
    )
    
    
    321,655Proceeds from issuance of long term debt
    
    
    
    
    
    
    Payments made on long term debt
    
    
    
    
    
    
    (90
    )Proceeds from Wachovia Facility
    
    
    3,000
    
    
    
    27,658Payments made on Wachovia Facility
    
    
    
    
    
    
    (3,857
    )Payments of debt issuance costs
    
    
    (267
    )
    
    
    (1,355
    )Dividends paid
    
    
    (21,736
    )
    
    
    (21,723
    )Payments made on short term debt
    
    
    (648
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (3,880,179
    )
    
    
    322,288Foreign currency translation
    
    
    (20
    )
    
    
    Net (decrease) increase in cash and cash equivalents
    
    
    (90,156
    )
    
    
    41,228Cash and cash equivalents at beginning of period
    
    
    113,733
    
    
    
    72,523Cash and cash equivalents at end of period
    
    $
    23,577
    
    
    $
    113,751
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DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (Continued)
 Three months ended March 31,2008
    
    2007(In thousands)SUPPLEMENTAL DISCLOSURE:Cash paid for interest
    
    $
    81,881
    
    
    $
    113,622Cash paid for income tax
    
    
    1,299
    
    
    
    NONCASH INVESTING AND FINANCING ACTIVITIES:Unsettled available-for-sale securities purchases  due to broker
    
    
    
    
    
    
    182,590Unsettled available-for-sale securities sales  due from broker
    
    
    
    
    
    
    414,873Non-cash settlement of interest expense from derivatives
    
    
    
    
    
    
    2,028Non-cash purchase of warrants
    
    
    1,092
    
    
    
    Non-cash settlement of interest income added to principal balance of loans
and loans held for sale
    
    
    1,684
    
    
    
    934Issuance of stock for payment of prior year incentive fee
    
    
    
    
    
    
    3Grant of performance shares
    
    
    2,789
    
    
    
    Series A cumulative convertible preferred stock dividend and accretion
    
    
    2,393
    
    
    
    
  9




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##### Table of Contents



DEERFIELD CAPITAL CORP. AND ITS SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. ORGANIZATION
   Business Segments
  Principal Investing
 Investment Management
 Liquidity and Capital Resources
    10




---



##### Table of Contents



2. ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS
 Basis of Presentation
 Principles of Consolidation Consolidation of
Variable Interest Entities
 Reclassifications
 Significant Accounting Policies Fair Value Measurements The Fair Value Option for Financial Assets and Liabilities .
 Fair Value Measurements and Presentation
 .
 Level 1
  11




---



##### Table of Contents



Level 2
  Level 3
        Recent Accounting Pronouncements
 Accounting for Transfers of
Financial Assets and Repurchase Financing Transactions Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ,
 12




---



##### Table of Contents



Disclosures about Derivative Instruments and
Hedging Activities Accounting for Derivative Instruments and Hedging Activities
 3. MERGER WITH DEERFIELD
   Unaudited Pro formaThree months ended March 31, 2007(In thousands, except per share data)Total net revenues
    
    $
    30,991Income before income tax expense
    
    $
    21,397Net income
    
    $
    21,951Net income attributable to common stockholders
    
    $
    15,795Net income per share  basic
    
    $
    0.31Net income per share  diluted
    
    $
    0.24
  4. FAIR VALUE OF FINANCIAL INSTRUMENTS
  Available-for-sale securities
  13




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##### Table of Contents



Trading securities
    Derivative assets and liabilities
  Loans held for sale
  Assets and liabilities measured at fair value on a recurring basis
  Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Carrying Value(in thousands)Available-for-sale securities
    
    $
    
    
    
    $
    
    
    
    $
    9,935
    
    
    $
    9,935Trading securities
    
    
    
    
    
    
    1,437,203
    
    
    
    32,539
    
    
    
    1,469,742Derivative assets
    
    
    
    
    
    
    
    
    
    
    1,221
    
    
    
    1,221Total
financial instruments assets
    
    $
    
    
    
    $
    1,437,203
    
    
    $
    43,695
    
    
    $
    1,480,898Derivative liabilities
    
    $
    
    
    
    $
    15,537
    
    
    $
    1,912
    
    
    $
    17,449
 14




---



##### Table of Contents



Changes in Level 3 recurring fair value measurements
  Changes in UnrealizedFair value measurements using significant unobservable inputs

    
    
    Gains/(Losses) Related toEstimated Fair Value
    
    
    Net Realized/Unrealized
    
    
    Purchases, Sales, Issuances
    
    
    Net Transfers Out
    
    
    Estimated Fair Value
    
    
    Financial Instruments HeldJanuary 1, 2008
    
    
    Losses
    
    
    and Settlements, Net
    
    
    of Level 3
    
    
    March 31, 2008
    
    
    at March 31, 2008(In thousands)Available-for-sale securities
    
    $
    10,268
    
    
    $
    (2,083)
    (1)
    
    $
    1,750
    
    
    $
    
    
    
    $
    9,935
    
    
    $
    (2,109)
    (1)Trading securities
    
    
    1,894,429
    
    
    
    (188,114)
    (2)
    
    
    (1,644,040
    )
    
    
    (29,736)
    (4)
    
    
    32,539
    
    
    
    (13,484)
    (2)Derivative assets
    
    
    318
    
    
    
    (1,204)
    (3)
    
    
    2,107
    
    
    
    
    
    
    
    1,221
    
    
    
    104
    (3)Total
financial instruments assets
    
    $
    1,905,015
    
    
    $
    (191,401
    )
    
    $
    (1,640,183
    )
    
    $
    (29,736
    )
    
    $
    43,695
    
    
    $
    (15,489
    )Derivative liabilities
    
    $
    1,493
    
    
    $
    (689)
    (3)
    
    $
    1,108
    
    
    $
    
    
    
    $
    1,912
    
    
    $
    (551)
    (3)
 
 (1)
    
    Net unrealized changes in fair value for available-for-sale securities are reported as
an adjustment to accumulated other comprehensive loss on the condensed consolidated
statement of stockholders equity.(2)
    
    Net realized and unrealized gains (losses) on trading securities are reported within
net (loss) gain on trading securities in the condensed consolidated statements of
operations.(3)
    
    Net realized and unrealized gains (losses) on derivative assets and derivative
liabilities are recorded in net (loss) gain on derivatives in the condensed consolidated
statements of operations.(4)
    
    Net transfers out of Level 3 represent Agency RMBS priced by
management by reference to dealer quotes at
January 1, 2008 and using modeled valuation with inputs observable in the market as of
March 31, 2008.
 Assets measured at fair value on a nonrecurring basis
  Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Carrying Value(In thousands)Loans held for sale
    
    $
    
    
    
    $
    
    
    
    $
    246,548
    
    
    $
    246,548Loans
    
    
    
    
    
    
    
    
    
    
    3,069
    
    
    
    3,069Intangible assets, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1)Goodwill
    
    
    
    
    
    
    
    
    
    
    78,703
    
    
    
    78,703Total assets at fair value on a nonrecurring basis
    
    $
    
    
    
    $
    
    
    
    $
    328,320
    
    
    $
    328,320
 
 (1)
    
    Two intangible assets identified as a result of the Merger were impaired and marked to
fair value, which for both assets was zero as of March 31, 2008. See Note 11 for further
information.  15




---



##### Table of Contents



Three months endedMarch 31, 2008(In thousands)Loans held for sale
    
    $
    (21,789)
    (1)Loans
    
    
    (2,200)
    (2)Intangible assets, net
    
    
    (7,940)
    (3)Goodwill
    
    
    (19,966)
    (3)Total nonrecurring fair value losses
    
    $
    (51,895
    )
 
 (1)
    
    Changes in the fair value on loans held for sale are reported within net (loss) gain on
loans and loans held for sale in the condensed consolidated statements of operations.(2)
    
    Impairment charges to record loans to fair value are reported within provision for loan
losses in the condensed consolidated statements of operations.(3)
    
    Impairment charges to intangible assets and goodwill are reported within impairment of
intangible assets and goodwill in the condensed consolidated statements of operations. Disclosure About Fair Value of Financial Instruments,
  EstimatedCarrying
    
    FairValue
    
    Value(In thousands)Financial assets:Cash and cash equivalents (1)
    
    $
    23,577
    
    
    $
    23,577Restricted cash and cash equivalents (1)
    
    
    57,141
    
    
    
    57,141Available-for-sale securities (2)
    
    
    9,935
    
    
    
    9,935Trading securities (2)
    
    
    1,469,742
    
    
    
    1,469,742Other investments (3)
    
    
    5,472
    
    
    
    5,472Derivative assets (2)
    
    
    1,221
    
    
    
    1,221Loans held for sale (2)
    
    
    246,548
    
    
    
    246,548Loans, net
of allowance for loan losses (2) (3)
    
    
    420,403
    
    
    
    419,136Investment advisory fee receivables (1)
    
    
    4,927
    
    
    
    4,927Financial liabilities:Repurchase agreements (1)
    
    
    1,423,873
    
    
    
    1,423,873Derivative liabilities (2)
    
    
    17,449
    
    
    
    17,449Short term debt (1)
    
    
    1,063
    
    
    
    1,063Long term debt: (4)Wachovia Facility
    
    
    76,435
    
    
    
    76,435Market Square CLO
    
    
    276,000
    
    
    
    276,000DFR MM CLO
    
    
    231,000
    
    
    
    231,000Trust preferred securities
    
    
    123,717
    
    
    
    123,717Series A Notes & Series B Notes (5)
    
    
    71,314
    
    
    
    71,314
 
 (1)
    
    The carrying amounts approximate the fair value due to the short term nature of these
instruments.(2)
    
    The estimated fair values were determined in accordance with SFAS No.157 as described in
detail above.(3)
    
    It was not practicable to estimate the fair value of certain loans and other investments because they are not
traded in an active market, therefore, the carrying value has been displayed as an
approximation of fair value. If an independent pricing service cannot provide fair value
estimates for a given loan, the Company may determine estimated fair value based on some or
all of the following: (a) current financial information of the borrowing company and
performance against its operating plan; (b) changes in the fair value of collateral
supporting the loan; (c) changes to the market for the borrowing companys service or
product and (d) present value of projected future cash flows.(4)
    
    The carrying amount approximated fair value as the interest rate on all of the
Companys long term debt resets quarterly to short term market rates plus a fixed credit
spread.(5)
    
    See Note 15 for further information regarding the Series A Notes and Series B Notes. 16




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##### Table of Contents



5. FAIR VALUE OPTION
    6. AVAILABLE-FOR-SALE SECURITIES
  Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueSecurity Description
    
    (In thousands)High-yield corporate bonds held in Market Square
CLO
    
    $
    3,979
    
    
    $
    
    
    
    $
    (760
    )
    
    $
    3,219Asset-backed securities held in Market Square CLO
    
    
    1,750
    
    
    
    
    
    
    
    
    
    
    
    1,750CMBS
    
    
    4,847
    
    
    
    
    
    
    
    (2,023
    )
    
    
    2,824Other investments
    
    
    2,971
    
    
    
    
    
    
    
    (829
    )
    
    
    2,142Total
    
    $
    13,547
    
    
    $
    
    
    
    $
    (3,612
    )
    
    $
    9,935
  17




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##### Table of Contents



WeightedAmortized
    
    
    Estimated
    
    
    AverageCost
    
    
    Fair Value
    
    
    CouponWeighted Average Life
    
    (In thousands)Greater than one year and less
than five years
    
    $
    2,971
    
    
    $
    2,142
    
    
    
    4.93
    %Greater than
five years and less than ten years
    
    
    5,080
    
    
    
    4,319
    
    
    
    6.36
    %Greater than ten years
    
    
    5,496
    
    
    
    3,474
    
    
    
    7.03
    %Total
    
    $
    13,547
    
    
    $
    9,935
    
    
    
    6.28
    %
    Less than 12 Months
    
    
    More than 12 Months
    
    
    TotalNumber
    
    
    Estimated
    
    
    Gross
    
    
    Number
    
    
    Estimated
    
    
    Gross
    
    
    Number
    
    
    Estimated
    
    
    Grossof
    
    
    Fair
    
    
    Unrealized
    
    
    of
    
    
    Fair
    
    
    Unrealized
    
    
    of
    
    
    Fair
    
    
    UnrealizedSecurities
    
    
    Value
    
    
    Losses
    
    
    Securities
    
    
    Value
    
    
    Losses
    
    
    Securities
    
    
    Value
    
    
    Losses(Dollars in thousands)High-yield corporate bonds
held in Market Square CLO
    
    
    4
    
    
    $
    3,219
    
    
    $
    (760
    )
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    4
    
    
    $
    3,219
    
    
    $
    (760
    )CMBS
    
    
    8
    
    
    
    1,626
    
    
    
    (1,199
    )
    
    
    6
    
    
    
    1,197
    
    
    
    (824
    )
    
    
    14
    
    
    
    2,823
    
    
    
    (2,023
    )Other investments
    
    
    1
    
    
    
    2,142
    
    
    
    (829
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    2,142
    
    
    
    (829
    )Total temporarily impaired securities
    
    
    13
    
    
    $
    6,987
    
    
    $
    (2,788
    )
    
    
    6
    
    
    $
    1,197
    
    
    $
    (824
    )
    
    
    19
    
    
    $
    8,184
    
    
    $
    (3,612
    )
   
    
    severity of the impairment;
    
    the length of time and the extent to which the market value has been less than the amortized cost;
    
    whether the security has been downgraded by a rating agency;
    
    the financial condition of the investee and the prospect for future recovery; and
    
    the Companys intent and ability to hold the security for a period of time sufficient to allow
for any anticipated recovery in market value.
 Recognition of Interest Income and Impairment on Purchased and Retained Beneficial
Interests in Securitized Financial Assets
 18




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##### Table of Contents



Three months endedMarch 31, 2007(In thousands)Realized gains
    
    $
    4,566Realized losses
    
    
    (1,815
    )Net realized gains (losses)
    
    
    2,751Other-than-temporary impairment
    
    
    (202
    )Net gain (loss)
    
    $
    2,549
  7. TRADING SECURITIES
  EstimatedFair ValueSecurity Description
    
    (In thousands)RMBS:Agency RMBS
    
    $
    437,902AAA-rated non-Agency RMBS
    
    
    29,749U. S. Treasury bills
    
    
    999,300Preferred shares of CDOs
    
    
    2,791Total
    
    $
    1,469,742
   WeightedAmortized
    
    
    Estimated
    
    
    AverageCost
    
    
    Fair Value
    
    
    CouponWeighted Average Life
    
    (In thousands)Less than one year
    
    $
    999,212
    
    
    $
    999,300
    
    
    
    1.34
    %Greater than
one year and less than five years
    
    
    57,466
    
    
    
    55,627
    
    
    
    5.88
    %Greater than
five years and less than ten years
    
    
    414,767
    
    
    
    407,092
    
    
    
    5.23
    %Greater than ten years
    
    
    7,679
    
    
    
    7,723
    
    
    
    4.70
    %Total
    
    $
    1,479,124
    
    
    $
    1,469,742
    
    
    
    2.63
    %
 19




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##### Table of Contents



Three months ended March 31,2008
    
    
    2007(In thousands)Realized gains
    
    $
    43,536
    
    
    $
    113Realized losses
    
    
    (214,758
    )
    
    
    (65
    )Net realized gains (losses)
    
    $
    (171,222
    )
    
    
    48
 8. OTHER INVESTMENTS
 Cost Method Investments
  Equity Method Investments
  20




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##### Table of Contents



9. LOANS AND LOANS HELD FOR SALE
  Carrying ValueLoans Heldfor Sale (1)
    
    
    Loans
    
    
    TotalType of Loan
    
    (In thousands)Loans held in Market Square CLO
    
    $
    246,548
    
    
    $
    
    
    
    $
    246,548Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    
    
    
    
    277,481
    
    
    
    277,481Loans held in Wachovia Facility
    
    
    
    
    
    
    105,698
    
    
    
    105,698Other corporate leveraged loans
    
    
    
    
    
    
    23,798
    
    
    
    23,798Commercial real estate loans (2)
    
    
    
    
    
    
    20,926
    
    
    
    20,926$
    246,548
    
    
    
    427,903
    
    
    
    674,451Allowance for loan losses
    
    
    
    
    
    
    (7,500
    )
    
    
    (7,500
    )$
    420,403
    
    
    $
    666,951
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value.(2)
    
    Commercial real estate loans relating to participating interests in
commercial mortgage loans originated by HCC were written down to zero as
of March 31, 2008.     Allowance for Loan Losses2008
    
    
    2007(In thousands)Allowance for loan losses at January 1
    
    $
    5,300
    
    
    $
    2,000Provision for loan losses
    
    
    2,200
    
    
    
    1,800Allowance for loan losses at March 31
    
    $
    7,500
    
    
    $
    3,800
 21




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##### Table of Contents



10. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
   Notional
    
    
    
    
    
    
    
    
    
    
    Estimated NetCount
    
    
    Amount
    
    
    Assets
    
    
    Liabilities
    
    
    Fair Value(In thousands)Interest rate swaps
    
    
    22
    
    
    $
    525,000
    
    
    $
    
    
    
    $
    (15,369
    )
    
    $
    (15,369
    )Interest rate cap
    
    
    1
    
    
    
    40,000
    
    
    
    
    
    
    
    (168
    )
    
    
    (168
    )Credit default
swaps  protection
seller
    
    
    4
    
    
    
    15,000
    
    
    
    
    
    
    
    (648
    )
    
    
    (648
    )Total return swaps
    
    
    2
    
    
    
    14,476
    
    
    
    23
    
    
    
    (1,264
    )
    
    
    (1,241
    )Warrants
    
    
    4
    
    
    
    n/a
    
    
    
    1,198
    
    
    
    
    
    
    
    1,19833
    
    
    $
    594,476
    
    
    $
    1,221
    
    
    $
    (17,449
    )
    
    $
    (16,228
    )
 
 n/a  not applicable Interest Rate Swaps
  ,
  22




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##### Table of Contents



Interest Rate Cap
  Credit Default Swaps
  Total Return Swaps
  Warrants
  11. IMPAIRMENT OF INTANGIBLE ASSETS AND GOODWILL
   12. REPURCHASE AGREEMENTS
  23




---



##### Table of Contents



Overnight
    
    Between1 Day or
    
    2 and 30Less
    
    Days
    
    Total(In thousands)RMBS:Estimated fair value of
securities pledged,
including accrued interest (1)
    
    $
    7,036
    
    
    $
    433,572
    
    
    $
    440,608Repurchase agreement liabilities
associated
with these securities
    
    
    2,371
    
    
    
    422,472
    
    
    
    424,843Weighted average interest rate of
repurchase agreement liabilities
    
    
    3.04
    %
    
    
    3.23
    %
    
    
    3.23
    %U.S. Treasury bills:Estimated fair value of
securities pledged,
including accrued interest
    
    $
    
    
    
    $
    999,300
    
    
    $
    999,300Repurchase agreement liabilities
associated
with these securities
    
    
    
    
    
    
    997,708
    
    
    
    997,708Weighted average interest rate of
repurchase agreement liabilities
    
    
    
    
    
    
    1.50
    %
    
    
    1.50
    %Other investments:Estimated fair value of
securities pledged,
including accrued interest (1)
    
    $
    
    
    
    $
    2,147
    
    
    $
    2,147Repurchase agreement liabilities
associated
with these securities
    
    
    
    
    
    
    1,322
    
    
    
    1,322Weighted average interest rate of
repurchase agreement liabilities
    
    
    
    
    
    
    3.61
    %
    
    
    3.61
    %Total:Estimated fair value of
securities pledged,
including accrued interest (1)
    
    $
    7,036
    
    
    $
    1,435,019
    
    
    $
    1,442,055Repurchase agreement liabilities
associated
with these securities
    
    
    2,371
    
    
    
    1,421,502
    
    
    
    1,423,873Weighted average interest rate of
repurchase agreement liabilities
    
    
    3.04
    %
    
    
    2.02
    %
    
    
    2.02
    %
 
 (1)
    
    Represents the current fair value of securities delivered as
collateral at the inception of the repurchase agreement, including
accrued interest. 24




---



##### Table of Contents



Accrued InterestIncluded in
    
    
    Accrued InterestEstimated
    
    
    Included inFair Value of
    
    
    Repurchase AgreementSecurities Pledged
    
    
    LiabilitiesType of Investment Pledged
    
    (In thousands)RMBS
    
    $
    1,911
    
    
    $
    854U.S. Treasury bills
    
    
    
    
    
    
    208Other investments
    
    
    5
    
    
    
    2$
    1,916
    
    
    $
    1,064
  Weighted-AverageMaturity of RepurchaseAmount at Risk (1)
    
    
    Agreements(In thousands)
    
    
    (In days)Repurchase Agreement Counterparties:Bank of America Securities LLC
    
    $
    3,578
    
    
    
    7Barclays Bank Plc.
    
    
    1,325
    
    
    
    3Deutsche Bank Securities Inc.
    
    
    4,663
    
    
    
    1Fortis Securities LLC
    
    
    7,790
    
    
    
    4Lehman Brothers Inc.
    
    
    1,105
    
    
    
    14Total
    
    $
    18,461
    
    
    
    4
 
 (1)
    
    Equal to the fair value of securities pledged (including net
additional repurchase agreement collateral pledged of as March 31,
2008 of $279,016, which includes $1,224 of accrued interest) and
related accrued interest receivable and dividends, minus repurchase
agreement liabilities and related accrued interest payable.  13. SECURITIES RECEIVED AND PLEDGED AS COLLATERAL
   14. SHORT TERM DEBT
  25




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##### Table of Contents



15. LONG TERM DEBT
  Weighted
    
    
    Fair ValueCarrying
    
    
    Average
    
    
    of CollateralValue
    
    
    Rate
    
    
    (including accrued interest)(In thousands)Wachovia Facility
    
    $
    76,435
    
    
    
    5.28
    %
    
    $
    119,539Market Square CLO
    
    
    276,000
    
    
    
    4.39
    %
    
    
    270,528DFR MM CLO
    
    
    231,000
    
    
    
    4.48
    %
    
    
    310,957Trust preferred securities
    
    
    123,717
    
    
    
    6.02
    %
    
    
    n/aSeries A Notes & Series B Notes
    
    
    71,314
    
    
    
    9.73
    %
    
    
    197,366(
    1)Total long term debt
    
    $
    778,466
    
    
    
    5.25
    %
    
    $
    898,390
 
 (1)

    Includes the assets of Deerfield, as issuer of
the Series A Notes and Series B Notes, but does not include the
assets of any guarantors thereof.n/a  not applicable    16. STOCKHOLDERS EQUITY
   26




---



##### Table of Contents



Non-vested as of December 31, 2007
    
    
    97,403Granted
    
    
    Vested
    
    
    (32,468
    )Forfeiture
    
    
    (649
    )Non-vested as of March 31, 2008
    
    
    64,286
  17. COMPUTATION OF EARNINGS PER SHARE
  Three months ended March 31,2008
    
    
    2007(in thousands, except per share data)Net (loss) income
    
    $
    (463,610
    )
    
    $
    22,527Weighted average shares used in basic computation:Common Stock
    
    
    54,965
    
    
    
    51,587Dilutive effect of:Unvested restricted stock
    
    
    
    
    
    
    96Unexercised options to purchase common stock
    
    
    
    
    
    
    80Weighted average shares used in diluted computation
    
    
    54,965
    
    
    
    51,763Net (loss) income per share  basic
    
    $
    (8.43
    )
    
    $
    0.44Net (loss) income per share  diluted
    
    $
    (8.43
    )
    
    $
    0.44
  27




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##### Table of Contents



18. ACCUMULATED OTHER COMPREHENSIVE LOSS
  For the three months ended March 31, 2008Available-for-
    
    
    Cash Flow
    
    
    Foreign CurrencySale Securities
    
    
    Hedges
    
    
    Translation
    
    
    Total(In thousands)Beginning balance  December 31, 2007
    
    $
    13,413
    
    
    $
    (97,239
    )
    
    $
    43
    
    
    $
    (83,783
    )Unrealized net loss for the period
    
    
    (2,111
    )
    
    
    
    
    
    
    
    
    
    
    (2,111
    )Cumulative effect adjustment from the
adoption of SFAS No. 159
    
    
    (14,914
    )
    
    
    
    
    
    
    
    
    
    
    (14,914
    )Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    28Reclassification adjustments:Accelerated amortization (1)
    
    
    
    
    
    
    91,651
    
    
    
    
    
    
    
    91,651Hedging amortization recognized in
earnings
    
    
    
    
    
    
    5,253
    
    
    
    
    
    
    
    5,253Ending balance  March 31, 2008
    
    $
    (3,612
    )
    
    $
    (335
    )
    
    $
    71
    
    
    $
    (3,876
    )
 
 (1)
    
    Due to the repayments of repurchase agreement obligations during the three months ended
March 31, 2008, $91.7 million was reclassified from other
comprehensive loss to net (loss) gain on derivatives related to the change in forecasted repurchase agreement
transactions. 19. INCOME TAXES
        28




---



##### Table of Contents



20. SEGMENT REPORTING
   For three months ended March 31, 2008(In thousands)InvestmentPrincipal Investing
    
    
    Management
    
    
    Eliminations
    
    
    ConsolidatedInterest income
    
    $
    61,008
    
    
    $
    342
    
    
    $
    
    
    
    $
    61,350Interest expense
    
    
    45,629
    
    
    
    1,971
    
    
    
    
    
    
    
    47,600Net interest income (expense)
    
    
    15,379
    
    
    
    (1,629
    )
    
    
    
    
    
    
    13,750Total net revenues
    
    
    13,179
    
    
    
    14,449
    
    
    
    (3,959
    )(1)
    
    
    23,669Net loss
    
    
    (442,837
    )
    
    
    (20,773
    )
    
    
    
    
    
    
    (463,610
    )Depreciation and amortization
    
    
    
    
    
    
    2,687
    
    
    
    
    
    
    
    2,687Income tax expense (benefit)
    
    
    1,468
    
    
    
    (8,670
    )
    
    
    
    
    
    
    (7,202
    )As of March 31, 2008(In thousands)Identifiable assets
    
    $
    2,280,464
    
    
    $
    197,366
    
    
    $
    (1,528
    )(2)
    
    $
    2,476,302
 
 (1)
    
    Represents the fees charged to the Principal Investing segment by the Investment Management
segment on a cost plus basis for investment advisory, management and operational services.(2)
    
    Represents the payable for fees charged to the Principal Investing segment by the
Investment Management segment and the intercompany receivable from the Principal Investing
segment for expenses paid by the Investment Management segment which have not yet been
reimbursed by the Principal Investing segment. 21. COMMITMENTS AND CONTINGENCIES
 Legal Proceedings
  29




---



##### Table of Contents



Other Commitments
  22. SUBSEQUENT EVENTS
     30




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 Part I
- Item 1A. Risk Factors. Part I   Item 1. Financial
Statements
 General
  Overview
     
    
    Agency RMBS with an amortized cost of $4.6 billion were
sold at a net realized gain of $24.4 million.
 
    
    AAA-rated non-Agency RMBS with an amortized cost of $1.6 billion were sold at a net realized loss of $193.5 million.
 
    
    The net notional amount of interest rate swaps used to hedge the RMBS
portfolio was reduced by $6.2 billion. Net losses in
this portfolio since December 31, 2007 totaled $219.3 million.
 31




---



##### Table of Contents



Our Business
   Principal Investing Segment
  32




---



##### Table of Contents



March 31, 2008Carrying
    
    
    % of TotalValue
    
    
    InvestmentsPrincipal Investments
    
    (In thousands)Real Estate Investments:RMBS (1)
    
    $
    467,651
    
    
    
    21.7
    %Commercial
real estate loans and securities (2)
    
    
    23,750
    
    
    
    1.1
    %491,401
    
    
    
    22.8
    %Government Investments:U.S. Treasury bills
    
    
    999,300
    
    
    
    46.3
    %Corporate Investments:Corporate leverage loans:Loans held in DFR MM CLO
    
    
    277,481
    
    
    
    12.9
    %Loans held in Wachovia Facility
    
    
    105,698
    
    
    
    4.80
    %Other corporate leveraged loans (3)
    
    
    23,798
    
    
    
    1.20
    %Assets held in Market Square CLO (4)
    
    
    251,517
    
    
    
    11.7
    %Equity securities
    
    
    5,472
    
    
    
    0.2
    %Other investments
    
    
    2,142
    
    
    
    0.1
    %666,108
    
    
    
    30.9
    %Total Investments
    
    
    2,156,809
    
    
    
    100.0
    %Allowance for loan losses
    
    
    (7,500
    )Net Investments
    
    $
    2,149,309
 
 (1)
    
    RMBS are either Agency RMBS or AAA-rated non-Agency RMBS.(2)
    
    Commercial real estate loans and securities include participating interests in
commercial mortgage loans written down to zero as of March 31, 2008.(3)
    
    Other corporate leveraged loans exclude credit default and total return swaps.(4)
    
    Includes syndicated bank loans of $246.5 million, high yield corporate bonds of $3.2
million and ABS of $1.8 million as of March 31, 2008. Investment Management Segment
    33




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##### Table of Contents



AUM
  Number of
    
    
    AUM as ofAccounts
    
    
    April 1, 2008 (1)(In thousands)CDOs (2)Bank loans (3)
    
    
    16
    
    
    $
    5,907,280Investment grade credit
    
    
    2
    
    
    
    636,145Asset-backed securities
    
    
    13
    
    
    
    6,675,779Total CDOs
    
    
    31
    
    
    
    13,219,204Investment Funds (4)Fixed income arbitrage
    
    
    2
    
    
    
    618,540Separately Managed Accounts (5)
    
    
    6
    
    
    
    399,006Total AUM (6)
    
    
    
    
    
    $
    14,236,750
 
 (1)
    
    AUM numbers are reported as of April 1, 2008, rather than as of March
31, 2008, to be inclusive of investment fund contributions effective
on the first of the month.(2)
    
    CDO AUM numbers generally reflect the aggregate principal or notional
balance of the collateral and, in some cases, the cash balance held by
the CDOs and are as of the date of the last trustee report received
for each CDO prior to April 1, 2008. Our CDOs/Bank loans AUM includes
AUM related to our structured loan fund.(3)
    
    The AUM for our two Euro-denominated CDOs has been converted into U.S.
dollars using the spot rate of exchange on April 1, 2008.(4)
    
    The Number of Accounts for the Investment Funds does not include
feeder funds, although some of our management fees are paid pursuant
to contracts with those feeder funds.(5)
    
    AUM for certain of the separately managed accounts is a multiple of
the capital actually invested in such account. Management fees for
these accounts are paid on this levered AUM number.(6)
    
    Included in Total AUM are $294.7 million and $300.5 million related to
Market Square CLO and DFR MM CLO, respectively, which amounts are also
included in the total reported for the Principal Investing segment.
DCM manages these vehicles but is not contractually entitled to
receive any management fees from these CDOs for so long as 100% of the
equity is held by DC LLC or an affiliate thereof. All other amounts
included in the Principal Investing portfolio are excluded from Total
AUM. Trends
  Liquidity.
  34




---



##### Table of Contents



Credit spreads.
 CDO Financing and Management.
  Interest rate environment.
  Shape of the yield curve
 Valuation of Investments.
 Prepayment rates.
 35




---



##### Table of Contents



Investor Demand.
 Reliance on Agency Ratings.
 Critical Accounting Policies
  Fair Value of Financial Instruments
 Fair Value Measurements, .
 Level
1
  Level
2
  Level
3
  36




---



##### Table of Contents



Available-for-sale securities
   37




---



##### Table of Contents




    
    severity of impairment;
    
    the length of time and the extent to which the market value has been less than
the amortized cost;
    
    whether the security has been downgraded by a rating agency;
    
    the financial condition of the investee and the prospect for future recovery; and
    
    our intent and ability to hold the security for a period of time sufficient to
allow for any anticipated recovery in market value.
 Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securities Financial Assets,
 Trading securities
    Derivative assets and liabilities
  Loans Held for Sale
  Fair Value Option
 The Fair Value Option for Financial Assets
and Liabilities,
 38




---



##### Table of Contents



Interest Income Recognition
 Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases.
  Investment Advisory Fees
 Accounting for
Management Fees Based on a Formula
  Loans
  39




---



##### Table of Contents



Allowance and Provision for Loan Losses
 Accounting by Creditors for Impairment of a Loan
   Variable Interest Entities
 Consolidation of Variable Interest Entities
 Income Taxes
      40




---



##### Table of Contents



Recent Accounting Pronouncements
 Accounting for Transfers
of Financial Assets and Repurchase Financing Transactions Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities,
 Disclosures about Derivative Instruments and
Hedging Activities. Accounting for Derivative Instruments and Hedging Activities
 41




---



##### Table of Contents



Financial Condition
  Carrying ValueAvailable-for-
    
    
    Trading
    
    
    Other
    
    
    Loans HeldSale Securities
    
    
    Securities
    
    
    Investments
    
    
    For Sale
    
    
    Loans
    
    
    TotalSecurity Description
    
    
    
    
    
    
    
    
    
    (In thousands)RMBS (Agency/AAA-rated non-Agency)
    
    $
    
    
    
    $
    467,651
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    467,651U.S. Treasury bills
    
    
    
    
    
    
    999,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    999,300Corporate leveraged loans (1):Loans held in DFR MM CLO
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    277,481
    
    
    
    277,481Loans held in Wachovia Facility
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    105,698
    
    
    
    105,698Other corporate leveraged loans (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,798
    
    
    
    23,798Commercial mortgage-backed assets (3)
    
    
    2,824
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,926
    
    
    
    23,750Equity securities
    
    
    
    
    
    
    
    
    
    
    5,472
    
    
    
    
    
    
    
    
    
    
    
    5,472Total structured and syndicated assets
    
    
    2,824
    
    
    
    
    
    
    
    5,472
    
    
    
    
    
    
    
    427,903
    
    
    
    436,199Assets held in Market Square CLO (4)
    
    
    4,969
    
    
    
    
    
    
    
    
    
    
    
    246,548
    
    
    
    
    
    
    
    251,517Other investments and loans (5)
    
    
    2,142
    
    
    
    2,791
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,933Total alternative assets
    
    
    9,935
    
    
    
    2,791
    
    
    
    5,472
    
    
    
    246,548
    
    
    
    427,903
    
    
    
    692,649Total invested assets
    
    $
    9,935
    
    
    $
    1,469,742
    
    
    $
    5,472
    
    
    $
    246,548
    
    
    
    427,903
    
    
    $
    2,159,600Allowance for loan losses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,500
    )$
    420,403
 
 (1)
    
    Corporate leveraged loans exclude credit default swaps with an estimated net negative fair value of
$0.6 million and a $15.0 million gross notional value. Also excluded are total return swaps
with an estimated net negative fair value of $1.2 million and a $14.5 million notional
value.(2)
    
    This amount is reported gross of the $7.5 million allowance for loan losses.(3)
    
    Commercial mortgage-backed assets include participating interests in commercial
mortgage loans written down to zero as of March 31, 2008.(4)
    
    Includes syndicated bank loans of $246.5 million, high yield corporate bonds of
$3.2 million and asset-backed securities of $1.8 million as of March 31, 2008.(5)
    
    Other investments and loans includes $2.8 million of preferred shares of CDOs owned by
DCM and considered assets of our Investment Management segment. Residential Mortgage-Backed Securities
  March 31, 2008Agency
    
    
    AAA ratedRMBS
    
    
    non-Agency RMBS
    
    
    Total(In thousands)Trading securities  fair value
    
    $
    437,902
    
    
    $
    29,749
    
    
    $
    467,651
   42




---



##### Table of Contents



Leverage.
  Weighted AverageContractual
    
    
    ConstantPar
    
    
    Estimated
    
    
    
    
    
    
    Months to
    
    
    Yield to
    
    
    Maturity
    
    
    Prepayment
    
    
    ModifiedAmount
    
    
    Fair Value
    
    
    Coupon
    
    
    Reset (1)
    
    
    Maturity
    
    
    (Month/Year)
    
    
    Rate (2)
    
    
    Duration (3)Security Description
    
    (In thousands)Hybrid Adjustable Rate RMBS:Rate reset in 1 year or less
    
    $
    45,721
    
    
    $
    45,664
    
    
    
    6.06
    %
    
    
    6
    
    
    
    4.91
    %
    
    
    02/37
    
    
    
    12.9
    
    
    
    1.9Rate reset in 1 to 3 years
    
    
    236,812
    
    
    
    238,642
    
    
    
    4.83
    %
    
    
    22
    
    
    
    4.01
    %
    
    
    02/35
    
    
    
    14.7
    
    
    
    1.7Rate reset in 3 to 5 years
    
    
    95,909
    
    
    
    97,082
    
    
    
    5.12
    %
    
    
    43
    
    
    
    4.25
    %
    
    
    08/35
    
    
    
    11.5
    
    
    
    2.4Rate reset in 7 to 10 years
    
    
    39,227
    
    
    
    33,534
    
    
    
    5.61
    %
    
    
    93
    
    
    
    8.73
    %
    
    
    02/36
    
    
    
    9.4
    
    
    
    7.4Fixed Rate RMBS:30 year
    
    
    59,031
    
    
    
    52,729
    
    
    
    6.11
    %
    
    
    n/a
    
    
    
    8.27
    %
    
    
    06/35
    
    
    
    18.2
    
    
    
    7.0Total hybrid and fixed rate RMBS
    
    $
    476,700
    
    
    $
    467,651
 
 (1)
    
    Represents number of months before conversion to floating rate.(2)
    
    Constant prepayment rate refers to the expected average annualized percentage rate of
principal prepayments over the remaining life of the security. The values represented in
this table are estimates only and the results of a third party financial model.(3)
    
    Modified duration represents the approximate percentage change in market value per
100 basis point change in interest rates.
n/a  not applicable     43




---



##### Table of Contents



March 31, 2008Fair
    
    
    AmortizedValue
    
    
    CostExpected Life
    
    (In thousands)Greater than one year and less than five years
    
    $
    55,330
    
    
    $
    57,169Greater than five years and less than ten years
    
    
    404,628
    
    
    
    411,279Greater than ten years
    
    
    7,693
    
    
    
    7,649Total
    
    $
    467,651
    
    
    $
    476,097
  U.S. Treasury Bills
  Loans Held for Sale and Loans Held for Investment
  Carrying ValueLoans Heldfor Sale (1)
    
    
    Loans
    
    
    TotalType of Loan
    
    (In thousands)Loans held in Market Square CLO
    
    $
    246,548
    
    
    $
    
    
    
    $
    246,548Corporate leveraged loans:Loans held in DFR MM CLO
    
    
    
    
    
    
    277,481
    
    
    
    277,481Loans held in Wachovia Facility
    
    
    
    
    
    
    105,698
    
    
    
    105,698Other corporate leveraged loans
    
    
    
    
    
    
    23,798
    
    
    
    23,798Commercial real estate loans (2)
    
    
    
    
    
    
    20,926
    
    
    
    20,926$
    246,548
    
    
    
    427,903
    
    
    
    674,451Allowance for loan losses
    
    
    
    
    
    
    (7,500
    )
    
    
    (7,500
    )$
    420,403
    
    
    $
    666,951
 
 (1)
    
    Carrying value of loans held for sale is the lower of cost or fair value.(2)
    
    Commercial real estate loans relating to participating interests in commercial mortgage loans
originated by HCC were written down to zero as of March 31, 2008. Loans Held in Market Square CLO
  44




---



##### Table of Contents



Estimated
    
    
    Weighted AveragePar
    
    
    Carrying
    
    
    Fair
    
    
    
    
    
    
    ContractualMoodys
    
    Value
    
    
    Value
    
    
    Value
    
    
    Spread
    
    
    MaturityRating
    
    
    
    
    
    (In thousands)
    
    
    
    
    
    
    
    
    
    
    (Month/Year)Baa3
    
    $
    3,023
    
    
    $
    3,002
    
    
    $
    3,002
    
    
    
    2.25
    %
    
    
    05/13Ba1
    
    
    13,131
    
    
    
    12,172
    
    
    
    12,172
    
    
    
    1.63
    %
    
    
    06/11Ba2
    
    
    11,532
    
    
    
    10,800
    
    
    
    10,800
    
    
    
    1.82
    %
    
    
    08/13Ba3
    
    
    36,624
    
    
    
    31,934
    
    
    
    31,934
    
    
    
    2.15
    %
    
    
    01/13B1
    
    
    74,468
    
    
    
    66,466
    
    
    
    66,466
    
    
    
    2.51
    %
    
    
    06/11B2
    
    
    102,567
    
    
    
    90,733
    
    
    
    90,733
    
    
    
    2.90
    %
    
    
    03/13B3
    
    
    30,344
    
    
    
    25,912
    
    
    
    25,912
    
    
    
    3.38
    %
    
    
    01/13Ca
    
    
    1,592
    
    
    
    1,178
    
    
    
    1,178
    
    
    
    3.00
    %
    
    
    07/14Caa1
    
    
    993
    
    
    
    729
    
    
    
    729
    
    
    
    2.75
    %
    
    
    05/14Caa2
    
    
    2,809
    
    
    
    2,444
    
    
    
    2,444
    
    
    
    3.78
    %
    
    
    08/12Caa3
    
    
    2,490
    
    
    
    1,178
    
    
    
    1,178
    
    
    
    5.24
    %
    
    
    02/12$
    279,573
    
    
    $
    246,548
    
    
    $
    246,548
    
    
    
    2.66
    %
  Loans Held in DFR MM CLO
  WeightedCarrying
    
    
    AverageValue
    
    
    CouponType of Loan
    
    (In thousands)First lien secured
    
    $
    89,801
    
    
    
    9.02
    %Second lien secured
    
    
    164,829
    
    
    
    9.95
    %Mezzanine
    
    
    22,851
    
    
    
    14.25
    %$
    277,481
    
    
    
    10.00
    %
 Liabilities.
  45




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##### Table of Contents



Other Corporate Leveraged Loans
  WeightedCarrying
    
    
    AverageValue
    
    
    CouponType of Loan
    
    (In thousands)First lien secured loans
    
    $
    26,588
    
    
    
    9.51
    %Second lien secured loans
    
    
    66,679
    
    
    
    10.27
    %Mezzanine
    
    
    21,125
    
    
    
    16.37
    %Holding company
    
    
    15,104
    
    
    
    10.50
    %129,496
    
    
    
    11.14
    %Allowance for loan losses
    
    
    (7,500
    )$
    121,996
  Commercial Real Estate Loans (including participation interests)
   Preferred shares of CDOs
  Derivatives and Hedging
  Notional
    
    
    
    
    
    
    
    
    
    
    Estimated NetCount
    
    
    Amount
    
    
    Assets
    
    
    Liabilities
    
    
    Fair Value(In thousands)Interest rate swaps
    
    
    22
    
    
    $
    525,000
    
    
    $
    
    
    
    $
    (15,369
    )
    
    $
    (15,369
    )Interest rate cap
    
    
    1
    
    
    
    40,000
    
    
    
    
    
    
    
    (168
    )
    
    
    (168
    )Credit default swaps  protection seller
    
    
    4
    
    
    
    15,000
    
    
    
    
    
    
    
    (648
    )
    
    
    (648
    )Total return swaps
    
    
    2
    
    
    
    14,476
    
    
    
    23
    
    
    
    (1,264
    )
    
    
    (1,241
    )Warrants
    
    
    4
    
    
    
    
    
    
    
    1,198
    
    
    
    
    
    
    
    1,19833
    
    
    $
    594,476
    
    
    $
    1,221
    
    
    $
    (17,449
    )
    
    $
    (16,228
    )
  46




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##### Table of Contents



,
   Results of Operations
  47




---



##### Table of Contents

\

Summary
  Three Months Ended March 31,2008
    
    2007(In millions, except for per share data)Consolidated Statements of Operations Data:Net interest income after provision for loan losses
    
    $
    11.6
    
    
    $
    22.0Investment advisory fees
    
    $
    12.1
    
    
    $
    Total expenses
    
    $
    44.1
    
    
    $
    6.6Net other income and (loss) gain
    
    $
    (450.4
    )
    
    $
    7.5Net (loss) income
    
    $
    (463.6
    )
    
    $
    22.5Net (loss) income per share  diluted
    
    $
    (8.43
    )
    
    $
    0.44Metrics:Dividends declared (1)
    
    $
    
    
    
    $
    21.7Dividends declared per common share outstanding
    
    $
    
    
    
    $
    0.42Book value
per share outstanding
    
    $
    3.26
    
    
    $
    13.40AUM:Principal Investing segment (2)
    
    $
    2,419.3
    
    
    $
    8,956.1Investment Management segment (3) (4)
    
    $
    14,236.7
    
    
    $
    Leverage (5)
    
    
    10.1
    
    
    
    12.4Consolidated Balance Sheet Data (as of):Residential mortgage-backed securities
    
    $
    467.7
    
    
    $
    7,872.5U.S. Treasury bills
    
    $
    999.3
    
    
    $
    Total assets
    
    $
    2,476.3
    
    
    $
    9,985.4Repurchase agreements
    
    $
    1,423.9
    
    
    $
    7,692.2Long-term debt:Wachovia Facility
    
    $
    76.4
    
    
    $
    284.8Market Square CLO
    
    $
    276.0
    
    
    $
    276.0DFR MM CLO
    
    $
    231.0
    
    
    $
    Pinetree CDO
    
    $
    
    
    
    $
    287.7Trust preferred securities
    
    $
    123.7
    
    
    $
    123.7Series A Notes & Series B Notes
    
    $
    71.3
    
    
    $
    Stockholders equity
    
    $
    217.4
    
    
    $
    693.3
 
 (1)
    
    Dividends shown are reflected in the period to which they relate, rather than the period
declared.(2)
    
    AUM for the Principal Investing segment is reflected net of allowance for loan losses of
$7.5 million as of March 31, 2008.(3)
    
    AUM for our Investment Management Segment includes CDO AUM numbers, which generally
reflect the aggregate principal or notional balance of the collateral and, in some cases,
the cash balance held by the CDOs as of the date of the last trustee report received for
each CDO prior to the relevant measurement date. The AUM for our two Euro-denominated bank
loan CDOs have been converted into U.S. dollars using the appropriate spot rate of
exchange. AUM for our Investment Management Segment also includes AUM for our separately
managed accounts, which, in certain cases, is a multiple of the capital actually invested
in such account. Management fees for these accounts are paid on this levered AUM number.(4)
    
    Included in the Investment Management segment AUM are $294.7 million and $300.5 million
related to Market Square CLO
and DFR MM CLO, respectively, which amounts are also included in the Principal Investing
segment AUM. DCM manages these vehicles but is not contractually entitled to receive any
management fees from these CDOs for so long as 100% of the equity is held by DC LLC or an
affiliate thereof. All other amounts included in the Principal Investing segment AUM are
excluded from the Investment Management segment AUM.(5)
    
    Leverage is calculated by dividing our total debt (principal outstanding on repurchase
agreements, short term debt and long term debt) by total stockholders equity. 48




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##### Table of Contents



Results of Operations by Segment
  Three months ended March 31, 2008Principal
    
    
    InvestmentInvesting
    
    
    Management
    
    
    Eliminations
    
    
    
    
    
    
    Consolidated(In thousands)Net revenues
    
    $
    13,179
    
    
    $
    14,449
    
    
    $
    (3,959
    )(1)
    
    
    
    
    
    $
    23,669Expenses
    
    
    (6,301
    )
    
    
    (41,781
    )
    
    
    3,959
    (1)
    
    
    
    
    
    
    (44,123
    )Other income and gain (loss)
    
    
    (448,247
    )
    
    
    (2,111
    )
    
    
    
    
    
    
    
    
    
    
    (450,358
    )Income tax (expense) benefit
    
    
    (1,468
    )
    
    
    8,670
    
    
    
    
    
    
    
    
    
    
    
    7,202Net loss
    
    $
    (442,837
    )
    
    $
    (20,773
    )
    
    $
    
    
    
    
    
    
    
    $
    (463,610
    )
 
 (1)
    
    Represents the fees charged to the Principal Investing segment by the Investment Management
segment on a cost plus basis for investment advisory, management and operational services. Principal Investing Segment
 Revenues
  Three months ended March 31,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Principal Investing Segment RevenuesInterest income
    
    $
    61.0
    
    
    $
    122.7
    
    
    $
    (61.7
    )Interest expense
    
    
    45.6
    
    
    
    98.9
    
    
    
    53.3Net interest income
    
    
    15.4
    
    
    
    23.8
    
    
    
    (8.4
    )Provision for loan losses
    
    
    2.2
    
    
    
    1.8
    
    
    
    (0.4
    )Total Principal Investing segment revenues
    
    $
    13.2
    
    
    $
    22.0
    
    
    $
    (8.8
    )
 49




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##### Table of Contents



Net Interest Income
  Three months ended March 31,
    
    
    Variance
    
    
    % of total interest income2008
    
    
    2007
    
    
    2008 vs. 2007
    
    
    Three months ended March 31,(In millions)
    
    
    
    
    
    
    2008
    
    
    2007Real Estate Investments:RMBS
    
    $
    41.7
    
    
    $
    96.0
    
    
    $
    (54.3
    )
    
    
    68.3
    %
    
    
    78.3
    %Commercial real estate loans and securities
    
    
    1.2
    
    
    
    1.4
    
    
    
    (0.2
    )
    
    
    2.0
    %
    
    
    1.1
    %ABS held in Pinetree CDO
    
    
    
    
    
    
    5.4
    
    
    
    (5.4
    )
    
    
    0.0
    %
    
    
    4.4
    %Total real estate investments
    
    
    42.9
    
    
    
    102.8
    
    
    
    (59.9
    )
    
    
    70.3
    %
    
    
    83.8
    %Corporate Investments:Corporate loans and securities:Assets held in DFR MM CLO
    
    
    8.2
    
    
    
    
    
    
    
    8.2
    
    
    
    13.4
    %
    
    
    0.0
    %Assets held in Wachovia Facility
    
    
    3.4
    
    
    
    12.7
    
    
    
    (9.3
    )
    
    
    5.6
    %
    
    
    10.4
    %Other corporate leveraged loans
    
    
    0.4
    
    
    
    0.6
    
    
    
    (0.2
    )
    
    
    0.7
    %
    
    
    0.5
    %High yield corporate bonds
    
    
    
    
    
    
    0.3
    
    
    
    (0.3
    )
    
    
    0.0
    %
    
    
    0.2
    %Assets held in Market Square CLO
    
    
    5.2
    
    
    
    5.7
    
    
    
    (0.5
    )
    
    
    8.5
    %
    
    
    4.6
    %Treasuries and short-term investments
    
    
    0.9
    
    
    
    0.5
    
    
    
    0.4
    
    
    
    1.5
    %
    
    
    0.4
    %Other investments
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    0.0
    %
    
    
    0.1
    %Total corporate investments
    
    
    18.1
    
    
    
    19.9
    
    
    
    (1.8
    )
    
    
    29.7
    %
    
    
    16.2
    %Total interest income
    
    $
    61.0
    
    
    $
    122.7
    
    
    $
    (61.7
    )
    
    
    100.0
    %
    
    
    100.0
    %
   Three months ended March 31,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Repurchase agreements
    
    $
    31.3
    
    
    $
    97.3
    
    
    $
    (66.0
    )Hedging activity
    
    
    5.2
    
    
    
    (14.2
    )
    
    
    19.4Long term debt
    
    
    9.0
    
    
    
    14.6
    
    
    
    (5.6
    )Amortization of debt issuance cost
    
    
    0.1
    
    
    
    1.2
    
    
    
    (1.1
    )Total interest expense
    
    $
    45.6
    
    
    $
    98.9
    
    
    $
    (53.3
    )
   50




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##### Table of Contents



Provision for Loan Losses
  Expenses
  Three months ended March 31,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Base management fee expense (1)
    
    $
    4.0
    
    
    $
    3.3
    
    
    $
    0.7Incentive fee expense
    
    
    
    
    
    
    2.2
    
    
    
    (2.2
    )Total management and incentive fee expense to related party
    
    
    4.0
    
    
    
    5.5
    
    
    
    (1.5
    )Audit and audit-related fees
    
    
    0.7
    
    
    
    0.3
    
    
    
    0.4Legal fees
    
    
    0.1
    
    
    
    0.1
    
    
    
    Other professional fees
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.1Total professional services
    
    
    1.1
    
    
    
    0.6
    
    
    
    0.5Insurance expense
    
    
    0.6
    
    
    
    0.1
    
    
    
    0.5Board of directors fees
    
    
    0.2
    
    
    
    0.1
    
    
    
    0.1Banking and other administrative fees
    
    
    0.3
    
    
    
    0.1
    
    
    
    0.2Software and data feeds
    
    
    0.1
    
    
    
    0.1
    
    
    
    Other general and administrative fees
    
    
    
    
    
    
    0.1
    
    
    
    (0.1
    )Total general and administrative expense
    
    
    0.6
    
    
    
    0.4
    
    
    
    0.2Total Principal Investing segment expenses
    
    $
    6.3
    
    
    $
    6.6
    
    
    $
    (0.3
    )
 
 (1)
    
    Base management fee expense for the three months ended
March 31, 2008 includes $4.0 million of management fee
expense in conjunction with our new management agreement with DCM,
which is eliminated in consolidation.  51




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##### Table of Contents



Other Income and Gain (Loss)
  Three months ended March 31,
    
    
    Variance2008
    
    
    2007
    
    
    2008 vs. 2007(In millions)Net realized gain on available-for-sale securities
    
    $
    
    
    
    $
    2.8
    
    
    $
    (2.8
    )Other-than-temporary impairment on available-for-sale securities
    
    
    
    
    
    
    (0.2
    )
    
    
    0.2Net gain on available-for-sale securities
    
    
    
    
    
    
    2.6
    
    
    
    (2.6
    )Net realized loss on trading securities
    
    
    (169.1
    )
    
    
    
    
    
    
    (169.1
    )Net unrealized (loss) gain on trading securities
    
    
    (29.5
    )
    
    
    2.6
    
    
    
    (32.1
    )Net (loss) gain on trading securities
    
    
    (198.6
    )
    
    
    2.6
    
    
    
    (201.2
    )Net realized (loss) gain on loans
    
    
    (4.9
    )
    
    
    1.5
    
    
    
    (6.4
    )Net unrealized (loss) gain on loans
    
    
    (21.6
    )
    
    
    0.5
    
    
    
    (22.1
    )Net (loss) gain on loans
    
    
    (26.5
    )
    
    
    2.0
    
    
    
    (28.5
    )Net realized (loss) gain on interest rate swaps
    
    
    (267.3
    )
    
    
    0.2
    
    
    
    (267.5
    )Net realized (loss) gain on credit default swaps
    
    
    (2.1
    )
    
    
    0.6
    
    
    
    (2.7
    )Net realized loss on total return swaps
    
    
    (0.7
    )
    
    
    (0.2
    )
    
    
    (0.5
    )Net realized loss on interest rate floors
    
    
    (1.6
    )
    
    
    
    
    
    
    (1.6
    )Net unrealized gain (loss) on interest rate swaps
    
    
    48.0
    
    
    
    (0.8
    )
    
    
    48.8Net unrealized (loss) gain on credit default swaps
    
    
    (0.1
    )
    
    
    0.3
    
    
    
    (0.4
    )Net unrealized (loss) gain on total return swaps
    
    
    (0.5
    )
    
    
    0.6
    
    
    
    (1.1
    )Net unrealized gain (loss) on interest rate floors
    
    
    1.1
    
    
    
    (0.7
    )
    
    
    1.8Net unrealized loss on warrants
    
    
    (0.1
    )
    
    
    
    
    
    
    (0.1
    )Net loss on derivatives
    
    
    (223.3
    )
    
    
    
    
    
    
    (223.3
    )Dividend income
    
    
    0.1
    
    
    
    0.1
    
    
    
    Other net gain
    
    
    
    
    
    
    0.2
    
    
    
    (0.2
    )Dividend income and other net gain
    
    
    0.1
    
    
    
    0.3
    
    
    
    (0.2
    )Total other income and (loss) gain
    
    $
    (448.3
    )
    
    $
    7.5
    
    
    $
    (455.8
    )Total realized (loss) gain
    
    $
    (445.6
    )
    
    $
    5.2
    
    
    $
    (450.8
    )Total unrealized (loss) gain
    
    $
    (2.7
    )
    
    $
    2.3
    
    
    $
    (5.0
    )
   52




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##### Table of Contents



Income Tax Expense
  Investment Management Segment
  Revenues
  Three months ended March31, 2008(In thousands)Investment Management Segment RevenuesInterest income
    
    $
    342Interest expense
    
    
    1,971Net interest income
    
    
    (1,629
    )Investment advisory fees (1)
    
    
    16,078Total Investment Management segment
revenues
    
    $
    14,449
 
 (1)
    
    Investment advisory fees include intercompany investment advisory fees of $4.0 million,
calculated in conjunction with our management agreement, which are eliminated upon consolidation. Net Interest Income
  Investment Advisory Fees
  CDOs
  Three months ended March 31, 2008Senior management
    
    
    Subordinated
    
    
    
    
    
    
    Total CDO advisoryfees
    
    
    management fees
    
    
    Performance fees (1)
    
    
    fees(in thousands)Bank loans
    
    $
    2,638
    
    
    $
    3,242
    
    
    $
    
    
    
    $
    5,880ABS
    
    
    1,457
    
    
    
    217
    
    
    
    72
    
    
    
    1,746Investment grade credit
    
    
    222
    
    
    
    83
    
    
    
    
    
    
    
    305Total CDOs
    
    $
    4,317
    
    
    $
    3,542
    
    
    $
    72
    
    
    $
    7,931
 
 (1)
    
    Performance fees are generally earned after certain investors returns exceed a
specified internal rate of return, or IRR. For purposes of this and the
following table, and in accordance with our accounting policies, we also classify any previously
deferred senior or subordinated management fees that are subsequently paid as performance fees. 53




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##### Table of Contents



Three months ended March 31, 2008Effective Rate(2)
    
    
    Weighted
AverageContractual Rate(3)Senior
    
    
    Subordinated
    
    
    Senior
    
    
    SubordinatedAverage AUM (1)
    
    
    Management fee
    
    
    Management fee
    
    
    Management fee
    
    
    Management fee(in thousands)Bank loans (4)
    
    $
    5,255,918
    
    
    
    0.20
    %
    
    
    0.25
    %
    
    
    0.21
    %
    
    
    0.26
    %ABS:High-grade ABS
    
    
    3,760,481
    
    
    
    0.05
    %
    
    
    0.01
    %
    
    
    0.05
    %
    
    
    0.06
    %Other ABS
    
    
    3,017,669
    
    
    
    0.13
    %
    
    
    0.01
    %
    
    
    0.14
    %
    
    
    0.19
    %Total ABS
    
    
    6,778,150
    
    
    
    0.09
    %
    
    
    0.01
    %
    
    
    0.09
    %
    
    
    0.11
    %Investment grade credit
    
    
    646,821
    
    
    
    0.14
    %
    
    
    0.05
    %
    
    
    0.20
    %
    
    
    0.20
    %Total CDOs
    
    $
    12,680,889
    
    
    
    0.14
    %
    
    
    0.11
    %
    
    
    0.14
    %
    
    
    0.19
    %
 
 (1)
    
    Average AUM is calculated as the average
of the January 1, February 1 and March 1, 2008 AUM. CDO AUM numbers generally reflect the
aggregate principal or notional balance of the collateral and, in some cases, the cash balance
held by the CDO and are as of the date of the last trustee report received for each CDO prior
to the 1st of January, February or March, as appropriate. Our bank loans AUM total
includes AUM related to our structured loan fund.(2)
    
    The effective rate is calculated by taking the management fees earned during the three months
ended March 31, 2008 multiplied by four to annualize and divided by the average AUM. The
senior and subordinated management fee effective rates may differ from the contractual fee
rates for various reasons, including the following: (a) we may have entered into agreement
with specific investors pursuant to which our management fees are paid to those investors and
(b) our senior or subordinated management fees may be deferred as a result of certain
structural provisions built into the documents governing the CDO. In certain circumstances,
we may at a later date, and subject to certain performance triggers, be entitled to repayment
of the fees paid to investors described in (a) above.(3)
    
    The weighted average contractual senior and subordinated management fee rates are calculated
as the sum of the amounts obtained by multiplying the contractual fee rates for each CDO by
that CDOs Average AUM and dividing that number by the total Average AUM for the relevant
asset class.(4)
    
    The AUM for our two Euro-denominated CDOs have been converted to U.S. dollars using the spot
rate of exchange as of the respective AUM date. Market Square CLO and DFR MM CLO have been
excluded from all categories in this table as DCM manages these vehicles, but is not
contractually entitled to receive any third party management fees from these CDOs as long as
100% of the equity is held by DC LLC or an affiliate thereof. 54




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##### Table of Contents



Termination ofFirst Optional
    
    Auction Call
    
    Reinvestment
    
    MaturityClosing Date
    
    April 1, 2008 AUM (1)
    
    
    Call Date (2)
    
    Date (3)
    
    Period (4)
    
    DateMonth/Year
    
    (In thousands)
    
    
    Month/YearBank Loan CLOs:Rosemont CLO, Ltd.
    
    01/02
    
    $
    202,933
    
    
    10/05
    
    n/a
    
    01/07
    
    2013Forest Creek CLO Ltd.
    
    05/03
    
    
    324,033
    
    
    07/07
    
    n/a
    
    07/08
    
    2015Long Grove CLO Ltd.
    
    06/04
    
    
    401,188
    
    
    08/08
    
    n/a
    
    05/10
    
    2016Access Institutional Loan Fund (5)
    
    08/04
    
    
    223,707
    
    
    Variable
    
    n/a
    
    n/a
    
    2009(9)Castle Harbor II CLO Ltd. (5)
    
    12/04
    
    
    353,837
    
    
    01/10
    
    n/a
    
    07/10
    
    2017Market Square CLO Ltd. (6)
    
    05/05
    
    
    294,717
    
    
    07/07
    
    n/a
    
    04/11
    
    2017Cumberland II CLO Ltd.
    
    09/05
    
    
    389,481
    
    
    02/10
    
    n/a
    
    11/11
    
    2019Marquette Park CLO Ltd.
    
    12/05
    
    
    301,513
    
    
    04/10
    
    n/a
    
    01/12
    
    2020Bridgeport CLO Ltd.
    
    06/06
    
    
    502,505
    
    
    10/09
    
    n/a
    
    07/13
    
    2020Coltrane CLO p.l.c. (5), (8)
    
    11/06
    
    
    644,636
    
    
    01/13
    
    n/a
    
    01/14
    
    2022Burr Ridge CLO Plus Ltd.
    
    12/06
    
    
    301,161
    
    
    06/12
    
    n/a
    
    03/13
    
    2023Schiller Park CLO Ltd.
    
    05/07
    
    
    388,683
    
    
    07/11
    
    n/a
    
    04/13
    
    2021Bridgeport CLO II Ltd.
    
    06/07
    
    
    502,615
    
    
    12/10
    
    n/a
    
    09/14
    
    2021DFR Middle Market CLO Ltd. (6)
    
    07/07
    
    
    300,544
    
    
    07/10
    
    n/a
    
    07/10
    
    2019Bryn Mawr CLO II Ltd. (5)
    
    07/07
    
    
    312,338
    
    
    08/13
    
    n/a
    
    08/14
    
    2019Gillespie CLO PLC (8)
    
    08/07
    
    
    463,389
    
    
    02/13
    
    n/a
    
    08/13
    
    2023Total Bank Loan CLOs
    
    
    
    
    5,907,280ABS CDOs:Mid Ocean CBO 2000-1 Ltd.
    
    01/01
    
    
    142,980
    
    
    04/06
    
    n/a
    
    01/06
    
    2036Mid Ocean CBO 2001-1 Ltd.
    
    10/01
    
    
    151,100
    
    
    02/06
    
    n/a
    
    01/06
    
    2036Oceanview CBO I, Ltd.
    
    06/02
    
    
    222,864
    
    
    06/06
    
    06/12
    
    06/06
    
    2032, 2037(7)Northlake CDO I, Limited
    
    02/03
    
    
    227,848
    
    
    03/06
    
    03/13
    
    03/07
    
    2033Knollwood CDO Ltd.
    
    03/04
    
    
    269,751
    
    
    04/07
    
    04/12
    
    04/08
    
    2039River North CDO Ltd.
    
    01/05
    
    
    302,020
    
    
    02/09
    
    02/13
    
    02/09
    
    2040Buckingham CDO Ltd.
    
    07/05
    
    
    1,000,536
    
    
    08/10
    
    08/13
    
    08/10
    
    2040Pinetree CDO Ltd.
    
    11/05
    
    
    301,086
    
    
    01/10
    
    01/14
    
    01/10
    
    2045Buckingham CDO II Ltd.
    
    12/05
    
    
    1,274,076
    
    
    03/11
    
    03/14
    
    03/11
    
    2041Knollwood CDO II Ltd.
    
    07/06
    
    
    721,664
    
    
    07/09
    
    07/13
    
    n/a
    
    2046Buckingham CDO III Ltd.
    
    08/06
    
    
    1,465,377
    
    
    09/11
    
    09/14
    
    09/11
    
    2051Aramis CDO
    
    03/07
    
    
    233,444
    
    
    03/12
    
    n/a
    
    n/a
    
    2047Western Springs CDO Ltd.
    
    04/07
    
    
    363,033
    
    
    07/11
    
    07/13
    
    07/11
    
    2050Total ABS CDOs
    
    
    
    
    6,675,779Investment Grade Credit CDOs:Valeo Investment Grade CDO Ltd.
    
    01/01
    
    
    308,150
    
    
    01/05
    
    n/a
    
    01/06
    
    2013Valeo Investment Grade CDO II Ltd.
    
    05/01
    
    
    327,995
    
    
    06/05
    
    n/a
    
    06/06
    
    2013Total Investment Grade Credit CDOs
    
    
    
    
    636,145Total CDO AUM
    
    
    
    $
    13,219,204
 
 (1)
    
    CDO AUM numbers generally reflect the aggregate principal or notional balance of the
collateral and, in some cases, the cash balance held by the CDOs and are as of the date of the
last trustee report received for each CDO prior to April 1, 2008.(2)
    
    CDOs are generally callable by equity holders once per quarter beginning on the first option
call date and subject to satisfaction of certain conditions.(3)
    
    Asset-Backed CDOs generally contain a provision requiring the manager thereof to liquidate
the collateral held therein on the auction call date, subject to certain conditions,
generally including that the proceeds from any such liquidation be sufficient to redeem the
notes and pay certain additional expenses.(4)
    
    Termination of reinvestment period refers to the date after which we can no longer use
certain principal collections to purchase additional collateral and are instead required to
use such collections to deleverage the CDO.(5)
    
    These deals are market value CDOs. All other deals are cash flow CDOs.(6)
    
    We are not contractually entitled to receive any management fees from these CDOs as long as
100% of the equity is held by DC LLC or an affiliate thereof.(7)
    
    Maturity date varies by tranche of notes.(8)
    
    The AUM for our two Euro-denominated CLOs has been converted into U.S. dollars using the spot
rate of exchange on April 1, 2008.(9)
    
    Subject to a five year extension.   55




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Investment Funds and Separately Managed Accounts
   Three months ended March 31, 2008AUM as of
    
    Management Fee
    
    IncentiveNumber of Accounts
    
    April 1, 2008 (1)
    
    Rate
    
    Fee Rate
    

Average
AUM (1)(2)
    
    Management Fees
    
    Performance Fees(in thousands)
    
    
    
    
    
    
    
    
    
    (In thousands)Fixed
incomearbitrageinvestment funds (3)
    
    
    2
    
    
    $
    618,540
    
    
    
    1.50
    %
    
    
    20
    %
    
    $
    707,863
    
    
    $
    2,756
    
    
    $
    1,186Separately managed accounts
    
    
    6
    
    
    $
    399,006
    
    
    
    .10% - .35
    %
    
    
    n/a
    
    
    $
    403,941
    
    
    $
    246
    
    
    
    n/a
 
 (1)
    
    AUM is reported as of April 1, 2008, rather than as of March 31, 2008, to be inclusive of
investment fund contributions effective on the first of the month. The AUM for certain of the
separately managed accounts is a multiple of the capital actually invested in such account.
Management fees for these accounts are paid on this levered AUM number.(2)
    
    Average AUM is calculated as the average of the AUM on January 1, February 1 and March 1, 2008.(3)
    
    The Number of Accounts for the fixed income arbitrage investment funds does not include
feeder funds, although some of our management fees are paid pursuant to contracts with those
feeder funds.n/a  not applicable  Intercompany investment advisory fees
  56




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Expenses
  Three months ended March31, 2008(In millions)Salaries
    
    $
    4.3Incentive compensation
    
    
    4.3Severance expense
    
    
    0.3Employee benefits
    
    
    0.5Total compensation and benefits
    
    
    9.4Fixed asset depreciation
    
    
    0.3Intangible asset amortization
    
    
    2.4Total depreciation and amortization
    
    
    2.7Audit and audit-related fees
    
    
    0.2Other professional fees
    
    
    0.1Total professional services
    
    
    0.3Insurance expense
    
    
    0.2Rent expense
    
    
    0.6Software and data feeds
    
    
    0.5Other general and administrative fees
    
    
    0.2Total general and administrative expense
    
    
    1.3Impairment of intangible assets
    
    
    7.9Impairment of goodwill
    
    
    20.0Total impairment of intangible assets and goodwill
    
    
    27.9Total Investment Management segment expenses
    
    $
    41.8
    Other Income and Gain (Loss)
  57




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Income Tax Expense
  Off-Balance Sheet Arrangements
  Liquidity and Capital Resources
    
    
    Net loss from trading securities  $200.7 million
    
    Amortization of net loss on previously designated
derivatives  $96.9 million
    
    Net change in operating assets and liabilities  $71.2 million
    
    Impairment on intangible assets and goodwill  $27.9 million
    
    Net loss on loans and loans held for sale  $26.6 million
    
    Depreciation, amortization and non-cash expenses  $2.7 million
    
    Provision for loan losses  $2.2 million
    
    Net premium and discount amortization  $0.4 million
    
    Share-based compensation  $0.1 million
  
    
    Net loss  $463.6 million
    
    Net purchases of trading securities  $341.2 million
    
    Net changes in undesignated derivatives  $148.7 million
    
    Deferred tax benefit  $11.8 million
    
    Net purchases of loans held for sale  $1.9 million
   58




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##### Table of Contents



Liquidity
     Leverage
   Sources of Funds
  Principal Investing Segment
  TrustRepurchase
    
    Term
    
    Wachovia
    
    PreferredAgreements
    
    Financing
    
    Facility
    
    Securities
    
    Total(In thousands)Outstanding balance
    
    $
    1,423,873
    
    
    $
    507,000
    (1)
    
    $
    76,435
    
    
    $
    123,717
    
    
    $
    2,131,025Weighted average borrowing rate
    
    
    2.02
    %
    
    
    4.43
    %
    
    
    5.28
    %
    
    
    6.02
    %
    
    
    2.94
    %Weighted-average remaining
maturity (in years)
    
    
    0.01
    
    
    
    9.33
    (2)
    
    
    0.19
    
    
    
    27.43
    (3)
    
    
    4.00Carrying
value of collateral
(including accrued interest)
    
    $
    1,442,055
    
    
    $
    581,485
    
    
    $
    119,539
    
    
    
    n/a
    
    
    $
    2,143,079
 
 n/a
    
     not applicable(1)
    
    Excludes $19.0 million of DFR MM CLO debt that is owned by us and eliminated upon consolidation. Had this debt been included the
weighted-average borrowing rate would be 4.60%, and the weighted-average remaining maturity would be 9.38 years. 59




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##### Table of Contents



(2)
    
    $276.0 million of the term financing is callable quarterly, $231.0 million is callable after July 20, 2010, and quarterly thereafter.(3)
    
    $51.6 million of the trust preferred securities are callable after October 30, 2010, and $72.1 million are callable after October 30, 2011. Repurchase Agreements.
   Weighted-AverageMaturity ofRepurchaseAmount at Risk (1)
    
    
    Agreements(In thousands)
    
    
    (In days)Repurchase Agreement
Counterparties:Bank of America Securities LLC
    
    $
    3,578
    
    
    
    7Barclays Bank Plc.
    
    
    1,325
    
    
    
    3Deutsche Bank Securities Inc.
    
    
    4,663
    
    
    
    1Fortis Securities LLC
    
    
    7,790
    
    
    
    4Lehman Brothers Inc.
    
    
    1,105
    
    
    
    14Total
    
    $
    18,461
    
    
    
    4
 
 (1)
    
    Equal to the fair value of securities pledged (including net additional repurchase agreement
collateral pledged of as of March 31,
2007 of $279,016, which includes $1,224 of accrued interest and related accrued interest
receivable and dividends, minus
repurchase agreement liabilities and related accrued interest payable.  Wachovia Facility. Recent
Developments
 Trust Preferred Securities. Recent Developments
 60




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##### Table of Contents



Investment Management Segment
  SeriesShort Term
    
    A & BDebt (1)
    
    Notes
    
    Total(In thousands)Outstanding balance
    
    $
    1,063
    
    
    $
    71,314
    (2)
    
    $
    72,377Weighted average borrowing rate
    
    
    5.49
    %
    
    
    9.73
    %
    
    
    9.67
    %Weighted-average remaining
maturity (in years)
    
    
    0.33
    (3)
    
    
    4.75
    
    
    
    4.69Carrying
value of collateral
(including accrued interest)
    
    $
    2,464
    
    
    $
    197,366
    (4)
    
    $
    199,830
 
 (1)
    
    The short term debt consists of two limited recourse notes collateralized by investments in
preferred shares of CDOs we manage.(2)
    
    Principal outstanding of $73.9 million is presented net of a $2.6 million discount.(3)
    
    The short term debt does not have a stated maturity. The weighted average remaining
maturity is estimated based on the timing of payments of future management fees and preferred
share distributions that are required to be utilized to pay-down the loans.(4)
    
    Includes the assets of Deerfield, as issuer of the Series A
Notes and Series B Notes, but does not include the assets of any
guarantors thereof. Recent Developments
 Distribution Policy
    Recent Developments
  61




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Estimated REIT Taxable Income (Loss)
  62




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##### Table of Contents



Three months endedMarch 31, 2008(In thousands)GAAP net loss
    
    $
    (463,610
    )Adjustments to GAAP net loss:Difference in rate of amortization and accretion
    
    
    (1,372
    )Interest income on non-accrual loans
    
    
    508Tax hedge interest accrual
    
    
    (2,205
    )Tax hedge amortization of deferred swap gains (losses)
    
    
    (20,933
    )Reverse GAAP amortization of swap (gains) losses
    
    
    5,254Provision for loan losses
    
    
    2,200Bad debt expense
    
    
    (1,872
    )Tax capital losses in excess of capital gain
    
    
    304,559Security basis difference upon sale of RMBS
    
    
    (82,140
    )Gain on intercompany sale eliminated for GAAP
    
    
    41Security basis difference upon sale of other assets
    
    
    300Tax hedge/GAAP trading swap adjustments
    
    
    221,486Other unrealized (gain)/loss
    
    
    2,147Exclusion of taxable REIT subsidiary net income
    
    
    26,376Provision for income taxes
    
    
    (7,202
    )Other
book/tax adjustments
    
    
    21Net adjustments to GAAP net loss
    
    
    447,168Estimated REIT taxable loss
    
    $
    (16,442
    )
  Derivative Instruments and Hedging Activities
  63




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##### Table of Contents



Inflation
  Seasonality
  
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Interest Rate Risk
  Effect on Net Interest Income
   NotionalYear of
    
    AmountExpiration
    
    (In thousands)2008
    
    $
    314,0002009
    
    
    110,0002010
    
    
    16,0002011
    
    
    2012-2017
    
    
    85,000Total
    
    $
    525,000
  64




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##### Table of Contents



Extension Risk
   Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk
  Interest Rate Mismatch Risk
   Prepayment Risk
  65




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##### Table of Contents



Effect on Fair Value
    Interest Rates
    
    
    
    
    
    Interest RatesFall 100
    
    
    
    
    
    Rise 100Basis Points
    
    Unchanged
    
    Basis Points(In thousands)RMBSFair value
    
    $
    479,134
    
    
    $
    467,651
    
    
    $
    453,481Change in fair value
    
    $
    11,483
    
    
    
    
    
    
    $
    (14,170
    )Change as a percent of fair value
    
    
    2.46
    %
    
    
    
    
    
    
    (3.03
    )%Interest Rate Swaps and CapFair value
    
    $
    (23,398
    )
    
    $
    (15,537
    )
    
    $
    (8,208
    )Change in fair value
    
    $
    (7,861
    )
    
    
    
    
    
    $
    7,329Change as a percent of fair value
    
    
    n/m
    
    
    
    
    
    
    
    n/mNet Portfolio Impact
    
    $
    3,622
    
    
    
    
    
    
    $
    (6,841
    )
 
 n/m
    
     not meaningful   Risk Management
  
    
    attempting to structure our borrowing agreements to have a range of
different maturities, terms, amortizations and interest rate
adjustment periods;
 
    
    using interest rate derivatives including, swaps, caps, floors,
mortgage derivatives and forward sales, to adjust the interest rate
sensitivity of our RMBS and our borrowings; and
    
    actively managing, on an aggregate basis, the interest rate indices,
interest rate adjustment periods, and gross reset margins of our RMBS
and the interest rate indices and adjustment periods of our
borrowings.
 66




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##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of Effectiveness of Disclosure Controls and Procedures
  Change in Internal Control Over Financial Reporting
  Inherent Limitations on Effectiveness of Controls
  
 PART II. OTHER INFORMATION
 
 ITEM 1A. RISK FACTORS
 Part I 
Item 1A. Risk Factors
 We may fail to qualify as a REIT as a result of recent sales of our RMBS securities.
  67




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##### Table of Contents



Loss of our Investment Company Act of 1940, as amended, or 1940 Act, exemption would adversely
affect us and reduce the market price of our shares and our ability to pay dividends.
      Our common stock could be delisted by the New York Stock Exchange if we do not comply with its
continued listing standards.
   68




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##### Table of Contents



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  Conversion of 14,999,992 shares of Series A Preferred Stock into 14,999,992 shares of common stock:
 Votes
For
    

Votes
Against29,185,678
    

488,375
 Amendment and restatement of our Stock Incentive Plan to, among other matters, increase the shares
of common stock reserved for issuance under the plan from 2,692,313 to 6,136,725:
 Votes
For
    

Votes
Against27,428,880
    

2,2728,325
 
 ITEM 6. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 (b) Documents filed as part of this Report:
 Exhibit No.
    
    Description of Exhibit10.1
    
    
    Supplemental Indenture, dated May 6, 2008, by and
between Deerfield Capital LLC and The Bank of New
York Trust Company, National Association, as
trustee.10.2
    
    
    Supplemental Indenture, dated May 6, 2008, by and
between Deerfield Capital LLC and The Bank of New
York Trust Company, National Association, as
trustee.10.3
    
    
    Supplemental Indenture, dated May 6, 2008, by and
between Deerfield Capital LLC and The Bank of New
York Trust Company, National Association, as
trustee.10.4
    
    

Forbearance Agreement, dated as of May 12, 2008, by and among DWFC, LLC and Deerfield TRS (Bahamas)
Ltd., as borrowers, Deerfield Capital LLC, as originator and servicer, Wachovia Bank, National
Association, as swingline purchaser, Variable Funding Capital Company LLC, Wachovia Capital
Markets, LLC, as administrative agent and VFCC agent, Wachovia Bank, National Association, as
hedge counterparty and certain other parties from time to time party
thereto.10.5
    
    

Omnibus Amendment No. 1, dated as of May 12, 2008, to the Sale and Servicing Agreement dated as of
March 10, 2006, as amended, by and among Deerfield Capital LLC, as originator and servicer, DWFC, LLC and
Deerfield TRS (Bahamas) Ltd., as borrowers, Wachovia Capital Markets, LLC, as administrative agent
and VFCC agent, Variable Funding Capital Company LLC, as conduit purchaser, and Wachovia Bank,
National Association, as swingline purchaser.10.6
    
    
    Amendment No. 1, dated as of May 12, 2008, to the Note Purchase Agreement, dated as of
December 21, 2007 (the Series A NPA), by and among DFR Merger Company, LLC, Deerfield &
Company LLC, Deerfield Capital Corp., Triarc Companies, Inc. and the
Purchasers.10.7
    
    
    Amendment No. 1, dated as of May 12, 2008, to the Note Purchase Agreement, dated as of
December 21, 2007 (the Series B NPA), by and among DFR Merger Company, LLC, Deerfield &
Company LLC, Deerfield Capital Corp., Triarc Companies, Inc. and the
Purchasers.31.1
    
    
    Certification of Principal Executive Officer
Pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    Certification of Principal Financial Officer
Pursuant to Rule 13a-14(a) under the Securities
Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    Certification of Principal Executive Officer and
Principal Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
  
  By:
    /s/ JONATHAN W. TRUTTERJonathan W. Trutter, Chief Executive Officer(Principal Executive Officer)Date: May 12, 2008By:
    /s/ RICHARD G. SMITHRichard G. Smith, Senior Vice
President and Chief Financial Officer(Principal Financial and Accounting Officer) 70