Edgar Filing: DYNEX CAPITAL INC

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2009

Transition Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

Commission File Number: 1-9819

DYNEX CAPITAL, INC.

(Exact name of registrant as specified in its charter)

Virginia	52-1549373
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

4991 Lake Brook Drive, Suite 100, Glen Allen, Virginia	23060-9245
(Address of principal executive offices)	(Zip Code)

(804) 217-5800 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

On October 31, 2009, the registrant had 13,572,012 shares outstanding of common stock, $0.01 par value, which is the registrant’s only class of common stock.

DYNEX CAPITAL, INC.

FORM 10-Q

INDEX

			Page
PART I.	FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Condensed Consolidated Balance Sheets at September 30, 2009 (unaudited) and December 31, 2008	1

		Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and September 30, 2008 (unaudited)	2

		Condensed Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2009 and September 30, 2008 (unaudited)	3

		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and September 30, 2008 (unaudited)	4

		Notes to Unaudited Condensed Consolidated Financial Statements	5

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47

	Item 4.	Controls and Procedures	53

PART II.	OTHER INFORMATION

	Item 1.	Legal Proceedings	54

	Item 1A.	Risk Factors	55

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55

	Item 3.	Defaults Upon Senior Securities	55

	Item 4.	Submission of Matters to a Vote of Security Holders	55

	Item 5.	Other Information	55

	Item 6.	Exhibits	56

SIGNATURES			57

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DYNEX CAPITAL, INC.

CONDENSED CONSOLIDATED

BALANCE SHEETS

(amounts in thousands except share and per share data)

	September 30,			December 31,
	2009			2008
	(unaudited)
ASSETS
Agency MBS (including pledged Agency MBS of $552,970 and $300,277 at September 30, 2009 and December 31, 2008, respectively)	$	600,927		$	311,576
Securitized mortgage loans, net		225,731			243,827
Investment in joint venture		8,174			5,655
Other investments, net		8,439			12,735
		843,271			573,793

Cash and cash equivalents		21,749			24,335
Restricted cash		–			2,974
Other assets		7,526			6,089
	$	872,546		$	607,191

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Repurchase agreements	$	545,761		$	274,217
Securitization financing		148,184			178,165
Obligation under payment agreement		9,095			8,534
Other liabilities		5,745			5,866
		708,785			466,782

Commitments and Contingencies (Note 13)

Shareholders’ equity:
Preferred stock, par value $0.01 per share: 50,000,000 shares authorized, 9.5% Cumulative Convertible Series D; 4,221,539 shares issued and outstanding ($43,218 aggregate liquidation preference)		41,749			41,749
Common stock, par value $0.01 per share, 100,000,000 shares authorized, 13,572,012 and 12,169,762 shares issued and outstanding, respectively		136			122
Additional paid-in capital		376,659			366,817
Accumulated other comprehensive income (loss)		7,999			(3,949	)
Accumulated deficit		(262,782	)		(264,330	)
		163,761			140,409
	$	872,546		$	607,191

See notes to unaudited condensed consolidated financial statements.

DYNEX CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS

OF OPERATIONS (UNAUDITED)

(amounts in thousands except share and per share data)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Interest income:
Investments	$	9,448		$	7,719		$	28,735		$	20,375
Cash and cash equivalents		4			158			13			659
		9,452			7,877			28,748			21,034
Interest expense		(2,855	)		(5,090	)		(11,226	)		(13,325	)
Net interest income		6,597			2,787			17,522			7,709
Provision for loan losses		(248	)		(449	)		(566	)		(796	)

Net interest income after provision for loan losses		6,349			2,338			16,956			6,913

Equity in income (loss) of joint venture		1,620			(3,462	)		1,476			(5,153	)
Gain on sale of investments, net		–			331			220			2,381
Fair value adjustments, net		(457	)		1,461			(319	)		5,519
Other income		29			3,862			193			6,954
General and administrative expenses:
Compensation and benefits		(824	)		(609	)		(2,776	)		(1,693	)
Other general and administrative expenses		(715	)		(876	)		(2,245	)		(2,261	)

Net income		6,002			3,045			13,505			12,660
Preferred stock dividends		(1,003	)		(1,003	)		(3,008	)		(3,008	)

Net income to common shareholders	$	4,999		$	2,042		$	10,497		$	9,652

Weighted average common shares:
Basic		13,552			12,170			12,908			12,165
Diluted		17,776			12,173			17,131			16,393
Net income per common share:
Basic	$	0.37		$	0.17		$	0.81		$	0.79
Diluted	$	0.34		$	0.17		$	0.79		$	0.77

Dividends declared per common share	$	0.23		$	0.23		$	0.69		$	0.48

See notes to unaudited condensed consolidated financial statements.

DYNEX CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

Nine Months Ended September 30, 2009 and September 30, 2008

(amounts in thousands)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive (Loss) Income			Accumulated Deficit			Total
Balance at December 31, 2008	$	41,749	$	122	$	366,817	$	(3,949	)	$	(264,330	)	$	140,409
Net income		–		–		–		–			13,505			13,505
Other comprehensive income:
Change in market value of securities and other investments		–		–		–		11,461			–			11,461
Reclassification adjustment for joint venture’s other-than-temporary impairment		–		–		–		707			–			707
Reclassification adjustment for gain on sale of investments, net included in net income		–		–		–		(220	)		–			(220	)
Total comprehensive income														25,453
Dividends on common stock		–		–		–		–			(8,949	)		(8,949	)
Dividends on preferred stock		–		–		–		–			(3,008	)		(3,008	)
Common stock issuance		–		14		9,759		–			–			9,773
Vesting of restricted stock		–		–		83		–			–			83
Balance at September 30, 2009	$	41,749	$	136	$	376,659	$	7,999		$	(262,782	)	$	163,761

	Preferred Stock		Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive (Loss) Income			Accumulated Deficit			Total
Balance at December 31, 2007	$	41,749	$	121	$	366,716	$	1,093		$	(267,743	)	$	141,936
Cumulative effect of adoption of SFAS 159		–		–		–		–			943			943
Net income		–		–		–		–			12,660			12,660
Other comprehensive income:
Change in market value of securities and other investments		–		–		–		(4,753	)		–			(4,753	)
Reclassification adjustment for gain on sale of investments, net included in net income		–		–		–		(2,381	)		–			(2,381	)
Total comprehensive income														5,526
Dividends on common stock		–		–		–		–			(5,841	)		(5,841	)
Dividends on preferred stock		–		–		–		–			(3,008	)		(3,008	)
Stock option issuance		–		–		13		–			–			13
Grant and vesting of restricted stock		–		1		64		–			–			65
Balance at September 30, 2008	$	41,749	$	122	$	366,793	$	(6,041	)	$	(262,989	)	$	139,634

See notes to unaudited condensed consolidated financial statements.

DYNEX CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS

OF CASH FLOWS (UNAUDITED)

(amounts in thousands)

	Nine Months Ended
	September 30,
	2009			2008
Operating activities:
Net income	$	13,505		$	12,660
Adjustments to reconcile net income to cash provided by operating activities:
Equity in (income) loss of joint venture		(1,476	)		5,153
Provision for loan losses		566			796
Gain on sale of investments, net		(220	)		(2,381	)
Fair value adjustments, net		319			(5,519	)
Amortization and depreciation		1,812			(1,694	)
Stock based compensation expense (benefit)		426			(263	)
Net change in other assets and other liabilities		(2,645	)		(4,134	)
Net cash provided by operating activities		12,287			4,618

Investing activities:
Principal payments received on securitized mortgage loans		17,332			28,008
Purchases of Agency MBS		(364,575	)		(343,941	)
Purchases of other investments		–			(9,988	)
Payments received on Agency MBS and other investments		86,448			21,171
Proceeds from sales of other investments		3,699			19,188
Proceeds from sales of Agency MBS		–			29,744
Other		(1,796	)		(2,882	)
Net cash used by investing activities		(258,892	)		(258,700	)

Financing activities:
Net borrowings under repurchase agreements		271,544			261,207
Principal payments on securitization financing		(13,256	)		(17,217	)
Decrease in restricted cash		2,974			–
Redemption of securitization financing		(15,493	)		–
Proceeds from issuance of common stock		9,884			–
Dividends paid		(11,634	)		(8,849	)
Net cash provided by financing activities		244,019			235,141

Net decrease in cash and cash equivalents		(2,586	)		(18,941	)
Cash and cash equivalents at beginning of period		24,335			35,352
Cash and cash equivalents at end of period	$	21,749		$	16,411

Supplemental disclosure of non-cash financing activities:
Dividends declared and unpaid	$	4,125		$	3,802

See notes to unaudited condensed consolidated financial statements.

DYNEX CAPITAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2009

(amounts in thousands except share and per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10, Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. The unaudited condensed consolidated financial statements include the accounts of Dynex Capital, Inc. and its qualified real estate investment trust ("REIT") subsidiaries and its taxable REIT subsidiary (together, “Dynex” or the “Company”). All intercompany balances and transactions have been eliminated in consolidation.

In the opinion of management, all significant adjustments, consisting of normal recurring accruals considered necessary for a fair presentation of the condensed consolidated financial statements, have been included. Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for any other interim periods or for the entire year ending December 31, 2009. Certain information and footnote disclosures normally included in the audited consolidated financial statements prepared in accordance with GAAP have been omitted. The unaudited condensed consolidated financial statements included herein should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC.

Consolidation of Subsidiaries

The Company consolidates entities in which it owns more than 50% of the voting equity and control does not rest with others, and variable interest entities in which it is determined to be the primary beneficiary in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810. The Company follows the equity method of accounting for investments with greater than 20% and less than a 50% interest in partnerships and corporate joint ventures or when it is able to influence the financial and operating policies of the investee but owns less than 50% of the voting equity.

Use of Estimates

The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates. The most significant estimates used by management include but are not limited to allowance for loan losses, fair value measurements, other-than-temporary impairments, commitments and contingencies, and amortization of yield adjustments.

Federal Income Taxes

The Company believes it has complied with the requirements for qualification as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). As such, the Company believes that it qualifies as a REIT for federal income tax purposes, and that it generally will not be subject to federal income tax on the amount of its income or gain that is distributed as dividends to shareholders. The Company uses the calendar year for both tax and financial reporting purposes. There may be differences between taxable income and income computed in accordance with GAAP.

Investments

The Company’s investments include Agency mortgage backed securities (“MBS”), securitized mortgage loans, investment in joint venture and other investments.

Agency MBS. Agency MBS are MBS issued or guaranteed by a federally chartered corporation, such as Federal National Mortgage Corporation, or Fannie Mae, or Federal Home Loan Mortgage Corporation, or Freddie Mac, or an agency of the U.S. government, such as Government National Mortgage Association, or Ginnie Mae. The Company’s Agency MBS are comprised primarily of Hybrid Agency ARMs and Agency ARMs and, to a lesser extent, fixed-rate Agency MBS. Hybrid Agency ARMs are MBS collateralized by hybrid adjustable rate mortgage loans. Hybrid adjustable rate mortgage loans have a fixed-rate of interest for a specified period of typically three to ten years which then reset their interest rates at least annually to an increment over a specified interest rate index as further discussed below. Agency ARMs are MBS collateralized by adjustable rate mortgage loans, with interest rates that will adjust within twelve months to an increment over a specified interest rate index. Agency ARMs include Hybrid Agency ARMs that are past their fixed-rate periods or are within twelve months of their initial reset.

Interest rates on the adjustable rate mortgage loans collateralizing the Hybrid Agency ARMs or Agency ARMs are based on specific index rates, such as the one-year constant maturity treasury, or CMT rate, the London Interbank Offered Rate, or LIBOR, the Federal Reserve U.S. 12-month cumulative average one-year CMT, or MTA, or the 11th District Cost of Funds Index, or COFI. These mortgage loans will typically have interim and lifetime caps on interest rate adjustments, or interest rate caps, limiting the amount that the rates on these mortgage loans may reset in any given period. Substantially all of the Company’s Agency MBS are pledged as collateral against repurchase agreements. The Company’s Agency MBS are classified as available-for-sale and are reported at fair value.

Securitized Mortgage Loans. Securitized mortgage loans consist of loans pledged to support the repayment of securitization financing bonds issued by the Company. Securitized mortgage loans are reported at amortized cost. An allowance has been established for currently existing estimated losses on such loans. Securitized mortgage loans can only be sold subject to the lien of the respective securitization financing indenture.

Allowance for Loan Losses. An allowance for loan losses has been estimated and established for currently existing and probable losses for mortgage loans that are considered impaired. Provisions made to increase the allowance are charged as a current period expense. Commercial mortgage loans are secured by income-producing real estate and are evaluated individually for impairment when the debt service coverage ratio on the mortgage loan is less than 1:1 or when the mortgage loan is delinquent. An allowance may be established for a particular impaired commercial mortgage loan. Commercial mortgage loans not evaluated for individual impairment or not deemed impaired are evaluated for a general allowance. Certain of the commercial mortgage loans are covered by mortgage loan guarantees that limit the Company’s exposure on these mortgage loans. Single family mortgage loans are considered homogeneous and according are evaluated on a pool basis for a general allowance.

The Company considers various factors in determining its specific and general allowance requirements. Such factors considered include whether a loan is delinquent, the Company’s historical experience with similar types of loans, historical cure rates of delinquent loans, and historical and anticipated loss severity of the mortgage loans as they are liquidated. The factors may differ by mortgage loan type (e.g., single-family versus commercial) and collateral type (e.g., multifamily versus office property). The allowance for loan losses is evaluated and adjusted periodically by management based on the actual and estimated timing and amount of probable credit losses, using the above factors, as well as industry loss experience.

In reviewing both general and specific allowance requirements for commercial mortgage loans, for loans secured by low-income housing tax credit (“LIHTC”) properties, the Company considers the remaining life of the tax compliance period in its analysis. Because defaults on mortgage loan financings for these properties can result in the recapture of previously received tax credits for the borrower, the potential cost of this recapture provides an incentive to support the property during the compliance period, which has historically decreased the likelihood of defaults.

Investment in Joint Venture. The Company accounts for its investment in joint venture using the equity method as it does not exercise control over significant asset decisions such as buying, selling or financing nor is it the primary beneficiary under ASC 810. Under the equity method, the Company increases its investment for its proportionate share of net income and contributions to the joint venture and decreases its investment balance by recording its proportionate share of net loss and distributions.

The Company periodically reviews its investment in joint venture for other-than-temporary declines in market value. Any decline that is not expected to be recovered in the next twelve months is considered other-than-temporary, and an impairment charge is recorded as a reduction to the carrying value of the investment.

Other Investments. Other investments may include non-Agency MBS and equity securities, and unsecuritized single-family and commercial mortgage loans. The unsecuritized mortgage loans are carried at amortized cost. Non-Agency MBS and equity securities are considered available-for-sale and are reported at fair value, with unrealized gains and losses excluded from earnings and reported as accumulated other comprehensive income.

Repurchase Agreements

The Company uses repurchase agreements to finance certain of its investments. Under these repurchase agreements, the Company sells the securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sales price. The difference between the sales price that the Company receives and the repurchase price that the Company pays represents interest paid to the lender. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing in accordance with the provision of ASC 860, “Transfers and Servicing”, under which the Company pledges its securities as collateral to secure a loan, which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. The Company retains beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender or, with the consent of the lender, the Company may renew the agreement at the then prevailing financing rate. A repurchase agreement lender may require the Company to pledge additional collateral in the event the estimated fair value of the existing pledged collateral declines. Repurchase agreement financing is recourse to the Company and the assets pledged. All of the Company’s repurchase agreements are based on the September 1996 version of the Bond Market Association Master Repurchase Agreement, which provides that the lender is responsible for obtaining collateral valuations from a generally recognized source agreed to by both the Company and the lender, or the most recent closing quotation of such source.

Interest Income

Interest income is recognized when earned according to the terms of the underlying investment and when, in the opinion of management, it is collectible. The accrual of interest is discontinued when, in the opinion of management, the interest is not collectible in the normal course of business, when the mortgage loan is significantly past due, or when the primary servicer of the mortgage loan fails to advance the interest and/or principal due on the mortgage loan. For securities and other investments, the accrual of interest is discontinued when, in the opinion of management, it is probable that all amounts contractually due will not be collected. Mortgage loans are considered past due when the borrower fails to make a timely payment in accordance with the underlying loan agreement, inclusive of all applicable cure periods. All interest accrued but not collected for investments that are placed on non-accrual status or are charged-off is reversed against interest income. Interest on these investments is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Investments are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Amortization of Premiums/Discounts on Agency MBS

Premiums and discounts on investments and obligations are amortized into interest income or expense, respectively, over the life of the related investment or obligation using the effective yield method in accordance with ACS 310-10, Receivables – Overall – Discounts and Premiums.

Other-than-Temporary Impairments

The Company evaluates all securities in its investment portfolio for other-than-temporary impairments. A security is generally defined to be impaired if the carrying value of such security exceeds its estimated fair value. Under the provisions of ASC 320, a security is considered to be other-than-temporarily impaired if the present value of cash flows expected to be collected is less than the security’s amortized cost basis (the difference being defined as the credit loss) or if the fair value of the security is less than the security’s amortized cost basis and the investor intends, or more-likely-than-not will be required, to sell the security before recovery of the security’s amortized cost basis. The charge to earnings is limited to the amount of credit loss if the investor does not intend, and it is more-likely-than-not that it will not be required, to sell the security before recovery of the security’s amortized cost basis. Any remaining difference between fair value and amortized cost is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. In certain instances, as a result of the other-than-temporary impairment analysis, the recognition or accrual of interest will be discontinued and the security will be placed on non-accrual status. Securities normally are not placed on non-accrual status if the servicer continues to advance on the impaired mortgage loans in the security.

Recently Issued Accounting Standards

In June 2009, the FASB issued FASB ASC 105, Generally Accepted Accounting Principles, which establishes the FASB Accounting Standards Codification (“ASC”) as the sole source of authoritative generally accepted accounting principles. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. Pursuant to the provisions of FASB ASC 105, the Company has updated references to GAAP in its unaudited condensed consolidated financial statements issued for the period ended September 30, 2009. The Company adopted the requirements of ASC 105 in the third quarter of 2009. This adoption did not have a material impact on the Company’s consolidated financial position or results of operations, as it does not alter existing GAAP.

In April 2009, the FASB updated ASC 825, Financial Instruments, to require a public entity to provide disclosures about fair value of financial instruments in interim financial information. The Company began including these required disclosures in its notes to unaudited condensed consolidated financial statements during the first quarter of 2009.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events which is codified in FASB ASC 855, Subsequent Events (“ASC 855”). ASC 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company adopted ASC 855 in the second quarter of 2009. The adoption of ASC 855 did not have a material effect on the Company’s consolidated financial statements.

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140 (“SFAS No. 166”), which amends the derecognition guidance in SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, eliminates the concept of a “qualifying special-purpose entity” (“QSPE”) and requires more information about transfers of financial assets, including securitization transactions as well as a company’s continuing exposure to the risks related to transferred financial assets. SFAS No. 166 has not yet been codified and, in accordance with ASC 105, remains authoritative guidance until such time that it is integrated in the FASB ASC. SFAS No. 166 is effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year that begins after November 15, 2009 and early adoption is prohibited. Management is currently evaluating the impact adoption of SFAS No. 166 will have on the Company’s consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS No. 167”), which amends the consolidation guidance applicable to variable interest entities. The amendments will significantly affect the overall consolidation analysis under FASB ASC 810, Consolidation (“ASC 810”) and changes the way entities account for securitizations and special purpose entities as a result of the elimination of the QSPE concept in

SFAS No.166. SFAS No. 167 has not yet been codified and, in accordance with ASC 105, remains authoritative guidance until such time that it is integrated in the FASB ASC. SFAS No. 167 is effective as of the beginning of the first fiscal year that begins after November 15, 2009 and early adoption is prohibited. Management is currently evaluating the impact adoption of SFAS No. 167 will have on the Company’s consolidated financial statements.

In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05 Fair Value Measurements and Disclosures (ASC 820): Measuring Liabilities at Fair Value (“ASU 2009-05”) which provides guidance on measuring the fair value of liabilities under FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”). ASU 2009-05 clarifies that the unadjusted quoted price for an identical liability, when traded as an asset in an active market is a Level 1 measurement for the liability and provides guidance on the valuation techniques to estimate fair value of a liability in the absence of a Level 1 measurement. ASU 2009-05 is effective for the first interim or annual reporting period beginning after its issuance. The adoption of ASU 2009-05 did not have a material effect on the Company’s consolidated financial statements.

FASB Accounting Standards Update 2009-12, Fair Value Measurements and Disclosures (ASC 820)—Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) amends ASC 820-10, Fair Value Measurements and Disclosures—Overall, to permit a reporting entity to measure the fair value of certain investments on the basis of the net asset value per share of the investment (or its equivalent). This Update also requires new disclosures, by major category of investments, about the attributes of investments within the scope of this amendment to the ASC. The guidance in this Update is effective for interim and annual periods ending after December 15, 2009. Management is currently evaluating the impact this Update will have on the Company’s consolidated financial statements.

NOTE 2 – NET INCOME PER COMMON SHARE

Net income per common share is presented on both a basic and diluted basis. Diluted net income per common share assumes the conversion of the convertible preferred stock into common stock using the two-class method, and stock options using the treasury stock method, but only if these items are dilutive. Each share of Series D preferred stock is convertible into one share of common stock. The following tables reconcile the numerator and denominator for both basic and diluted net income per common share for the three and nine months ended September 30, 2009 and September 30, 2008.

	Three Months Ended September 30,
	2009					2008
	Income			Weighted-Average Common Shares		Income			Weighted- Average Common Shares
Net income	$	6,002				$	3,045
Preferred stock dividends		(1,003	)				(1,003	)
Net income to common shareholders		4,999			13,551,994		2,042			12,169,762
Effect of dilutive items		1,003			4,224,346		–			2,761
Diluted	$	6,002			17,776,340	$	2,042			12,172,523

Net income per common share:
Basic				$	0.37				$	0.17
Diluted				$	0.34				$	0.17

Reconciliation of shares included in calculation of net income per common share due to dilutive effect:
Net effect of dilutive:
Convertible preferred stock	$	1,003			4,221,539	$	–			–
Stock options		–			2,807		–			2,761
	$	1,003			4,224,346	$	–			2,761

	Nine Months Ended September 30,
	2009					2008
	Income			Weighted-Average Common Shares		Income			Weighted- Average Common Shares
Net income	$	13,505				$	12,660
Preferred stock dividends		(3,008	)				(3,008	)
Net income to common shareholders		10,497			12,908,243		9,652			12,165,483
Effect of dilutive items		3,008			4,222,306		3,008			4,227,296
Diluted	$	13,505			17,130,549	$	12,660			16,392,779

Net income common per share:
Basic				$	0.81				$	0.79
Diluted				$	0.79				$	0.77

Reconciliation of shares included in calculation of net income per common share due to dilutive effect:
Net effect of dilutive:
Convertible preferred stock	$	3,008			4,221,539	$	3,008			4,221,539
Stock options		–			767		–			5,757
	$	3,008			4,222,306	$	3,008			4,227,296

The following securities were excluded from the calculation of diluted net income per common share, as their inclusion would be anti-dilutive:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2009		2008		2009		2008
Shares issuable under stock option awards		70,000		85,000		70,000		50,000
Convertible preferred stock		–		4,221,539		–		–

NOTE 3 – AGENCY MORTGAGE-BACKED SECURITIES

The following table presents the components of the Company’s investment in Agency MBS at September 30, 2009 and December 31, 2008:

	September 30, 2009			December 31, 2008
Principal/par value	$	576,573		$	307,548
Purchase premiums		12,993			3,585
Purchase discounts		(46	)		(59	)
Amortized cost		589,520			311,074
Gross unrealized gains		11,531			1,355
Gross unrealized losses		(124	)		(853	)
Fair value	$	600,927		$	311,576

Weighted average coupon		4.90	%		5.06	%
Weighted average months to reset		20			21

Principal/par value includes principal payments receivable on Agency MBS of $2,789 and $956 as of September 30, 2009 and December 31, 2008, respectively. As of September 30, 2009, the Company did not have any securities pending settlement. The Company’s investment in Agency MBS, including principal receivable on the securities, is comprised of $324,640 of Hybrid Agency ARMs, $276,148 of Agency ARMs, and $139 of fixed-rate Agency MBS. The Company received principal payments of $85,675 on its portfolio of Agency MBS and purchased approximately $364,575 of Agency MBS during the nine-month period ended September 30, 2009. The purchases were financed using approximately $334.0 million in repurchase agreements and $30.6 million in equity capital.

NOTE 4 – SECURITIZED MORTGAGE LOANS, NET

The following table summarizes the components of securitized mortgage loans at September 30, 2009 and December 31, 2008:

	September 30, 2009			December 31, 2008
Securitized mortgage loans:
Commercial mortgage loans	$	151,001		$	164,032
Single-family mortgage loans		63,887			70,607
		214,888			234,639
Funds held by trustees, including funds held for defeased loans		13,741			11,267
Accrued interest receivable		1,392			1,538
Unamortized discounts and premiums, net		(18	)		90
Other		(241	)		–
Loans, at amortized cost		229,762			247,534
Allowance for loan losses		(4,031	)		(3,707	)
	$	225,731		$	243,827

All of the securitized mortgage loans are encumbered by securitization financing bonds (see Note 9). The Company identified $16,732 of securitized commercial mortgage loans and $3,958 of securitized single-family mortgage loans as being impaired at September 30, 2009. For loans that were impaired at September 30, 2009, the Company recognized $285 and $882 of interest income on impaired securitized commercial mortgage loans and $47 and $147 on impaired single-family mortgage loans for the three-month and nine-month periods ended September 30, 2009, respectively.

NOTE 5 – ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is included in securitized mortgage loans, net as well as in other investments, net in the accompanying condensed consolidated balance sheets. The following table summarizes the aggregate activity for the allowance for loan losses for the three-month and nine-month periods ended September 30, 2009 and September 30, 2008:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Allowance at beginning of period	$	4,016		$	3,066		$	3,707		$	2,721
Provision for loan losses		248			449			566			796
Charge-offs, net of recoveries		(138	)		(3	)		(147	)		(5	)
Allowance at end of period	$	4,126		$	3,512		$	4,126		$	3,512

The following table presents the components of the allowance for loan losses at September 30, 2009 and December 31, 2008:

	September 30, 2009		December 31, 2008
Securitized commercial mortgage loans	$	3,785	$	3,527
Securitized single-family mortgage loans		246		180
		4,031		3,707
Other mortgage loans		95		–
	$	4,126	$	3,707

The following table presents certain information on impaired single-family and commercial mortgage loans at December 31, 2008 and September 30, 2009:

	September 30, 2009				December 31, 2008
	Commercial		Single-family		Commercial		Single-family
Investment in impaired loans	$	16,742	$	3,958	$	17,292	$	3,501
Allowance for loan losses		3,785		246		3,527		180
Investment in excess of allowance	$	12,957	$	3,712	$	13,765	$	3,321

NOTE 6 — INVESTMENT IN JOINT VENTURE

The Company, through a wholly-owned subsidiary, holds a 49.875% interest in a joint venture. The Company accounts for its investment in the joint venture using the equity method, under which it recognizes its proportionate share of the joint venture’s earnings or loss and changes in accumulated other comprehensive income or loss.

The joint venture owns interests in commercial mortgage backed securities (“CMBS”) and an investment in a payment agreement from the Company (see Note 10). The CMBS are considered available-for-sale and are carried at fair value by the joint venture. The payment agreement is a financial investment backed by commercial mortgage loans accounted for at fair value. Under the payment agreement, the Company owes the joint venture any amounts received on certain securitized mortgage loans in excess of payment on the associated securitization financing bonds outstanding. During the three and nine months ended September 30, 2009, the joint venture received $416 and $1,217 of payments under this payment agreement compared to $403 and $1,207 for the three and nine months ended September 30, 2008, respectively.

The Company recorded equity in the income of the joint venture of $1,620 for the three months ended September 30, 2009 compared to a loss of $3,462 for the three months ended September 30, 2008. The Company recorded an increase of $445 for its share of the decrease in the accumulated other comprehensive loss of the joint venture for the three months ended September 30, 2009 compared to $637 for the three months ended September 30, 2008. The Company recorded equity in the income of the joint venture of $1,476, net of $60 amortization expense, and an increase of $1,042 for its share of the decrease in the accumulated other comprehensive loss of the joint venture for the nine months ended September 30, 2009 compared to equity in the loss of the joint venture of $5,153 and an decrease of $3,287 for its share of the increase in the accumulated other comprehensive loss for the nine months ended September 30, 2008.

The following tables present the condensed results of operations for the joint venture for the three and nine months ended September 30, 2009 and September 30, 2008 and the financial condition as of September 30, 2009 and December 31, 2008 of the joint venture.

Condensed Statements of Operations
	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Interest income	$	622		$	903		$	1,870		$	3,392
Fair value adjustment		2,632			(1,584	)		2,652			(5,846	)
Other-than-temporary impairment		–			(6,073	)		(1,417	)		(7,277	)
Other expense		(6	)		(6	)		(25	)		(59	)
Net income (loss)	$	3,248		$	(6,760	)	$	3,080		$	(9,790	)

Condensed Balance Sheets
	September 30, 2009		December 31, 2008
Total assets	$	16,410	$	11,240
Total liabilities	$	21	$	21
Total members’ capital	$	16,389	$	11,219

The other-than-temporary impairment of $1,417 during the nine months ended September 30, 2009 and $7,277 for the nine months ended September 30, 2008 was related to the joint venture’s investment in subordinate CMBS.

NOTE 7 – OTHER INVESTMENTS

The following table summarizes the Company’s other investments at September 30, 2009 and December 31, 2008:

	September 30, 2009						December 31, 2008
	Carrying Value			Weighted Average Yield			Carrying Value			Weighted Average Yield
Non-Agency MBS	$	6,612			8.07	%	$	6,959			8.02	%
Equity securities of publicly traded companies		–						3,441
		6,612						10,400
Gross unrealized gains		490						802
Gross unrealized losses		(990	)					(1,335	)
		6,112						9,867
Other mortgage loans, net		2,188						2,657
Other		139						211
	$	8,439					$	12,735

Non-Agency MBS consist principally of fixed-rate securities collateralized by single-family residential mortgage loans originated in 1994.

The Company sold $3,443 of equity securities during the nine months ended September 30, 2009 on which it recognized a gain of $220.

Other mortgage loans are comprised principally of unsecuritized mortgage loans originated predominately between 1986 and 1997. Of the approximately 26 mortgage loans that make up the balance, one loan with an unpaid principal balance of $483 was more than 60 days delinquent as of September 30, 2009, representing approximately 16% of the outstanding unpaid principal balance of the mortgage loans. An allowance for loan losses of $95 has been recorded for this loan.

NOTE 8 – REPURCHASE AGREEMENTS

The Company uses repurchase agreements, which are recourse to the Company, to finance certain of its investments. The following tables present the components of the Company’s repurchase agreements by the type of securities collateralizing the repurchase agreement at September 30, 2009 and December 31, 2008, respectively.

	September 30, 2009
Collateral Type	Balance		Weighted Average Rate			Fair Value of Collateral
Agency MBS	$	516,627		0.39	%	$	552,970
Securitization financing bonds (see Note 9)		29,134		1.71	%		41,732
	$	545,761		0.46	%	$	594,702

	December 31, 2008
Collateral Type	Balance		Weighted Average Rate			Fair Value of Collateral
Agency MBS	$	274,217		2.70	%	$	300,277
Securitization financing bonds		–		–			–
	$	274,217		2.70	%	$	300,277

At September 30, 2009 and December 31, 2008, the repurchase agreements had the following original maturities:

Original Maturity	September 30, 2009		December 31, 2008
30 days or less	$	280,759	$	38,617
31 to 60 days		75,680		187,960
61 to 90 days		7,577		47,640
Greater than 90 days		181,745		–
	$	545,761	$	274,217

NOTE 9 – SECURITIZATION FINANCING

The Company, through limited-purpose finance subsidiaries, has issued bonds pursuant to indentures in the form of non-recourse securitization financing. Each series of securitization financing may consist of various classes of bonds, either at fixed or variable-rates of interest and having varying repayment terms. The Company, on occasion, may retain bonds or redeem bonds and hold such bonds outstanding for possible future resale or reissuance. Payments received on securitized mortgage loans and any reinvestment income earned thereon are used to make payments on the bonds.

The obligations under the securitization financings are payable solely from the securitized mortgage loans and are otherwise non-recourse to the Company. The stated maturity date for each class of bonds is generally calculated based on the final scheduled payment date of the underlying collateral pledged. The actual maturity of each class will be directly affected by the rate of principal prepayments on the related collateral. Each series is also subject to redemption at the Company’s option according to specific terms of the respective indentures. As a result, the actual maturity of any class of a series of securitization financing is likely to occur earlier than its stated maturity.

The Company has three series of bonds remaining outstanding pursuant to three separate indentures. One series with a principal amount of $25,079 at September 30, 2009, is collateralized by single-family mortgage loans with unpaid principal balances at September 30, 2009 of $25,778 and additional overcollateralization of $6,570. The two remaining series are fixed-rate with principal amounts of $215 and $123,741 at September 30, 2009, and are collateralized by commercial mortgage loans with unpaid principal balances at September 30, 2009 of $19,982 and $131,019, respectively.

In May 2009, the Company redeemed a securitization financing bond collateralized by commercial mortgage loans at its then par value of $15,493 and financed the redemption with an $11,039 repurchase agreement. At September 30, 2009, the par value of this bond is $15,115 and the balance of the repurchase agreement is $10,770. The bond is rated “AAA” and has a guaranty of payment by Fannie Mae. Because the redeemed bond is held by a subsidiary of the Company that is distinct from the bond’s issuer, to which the bonds are a liability, the bond is eliminated in the consolidated financial statements but remains legally outstanding. The Company has the right to redeem the one remaining bond outstanding in this series with a par value of $215 at September 30, 2009, but does not currently have any plans to call this bond. The Company also redeemed one additional securitization bond which has a par value of $31,539 at September 30, 2009 and is rated “AAA.” The bond, which is collateralized by single-family mortgage loans, was issued by the Company in 2002 and was redeemed in 2004. This bond is pledged as collateral to support repurchase agreement borrowings of $18,364.

The components of securitization financing along with certain other information at September 30, 2009 and December 31, 2008 are summarized as follows:

	September 30, 2009						December 31, 2008
	Bonds Outstanding			Range of Interest Rates			Bonds Outstanding			Range of Interest Rates
Fixed-rate classes	$	123,956			6.7% - 8.8	%	$	149,598			6.6% - 8.8	%
Variable-rate classes		25,079			0.6	%		28,186			1.7	%
Accrued interest payable		854						1,008
Unamortized net bond premium and deferred costs		(1,705	)					(627	)
	$	148,184					$	178,165

Range of stated maturities		2024-2027						2024-2027
Estimated weighted average life	3.3 years						2.6 years
Number of series		3						3

The estimated weighted average life of the bonds increased as a result a decrease in the expected prepayment speed of the commercial mortgage loans collateralizing the bonds, which are the source of funds that are used to pay down the bonds. The extension of the estimated cash flows of the bond resulted in an adjustment to the amortization of the net bond premium and deferred costs of approximately $789 during the nine months ended September 30, 2009. At September 30, 2009, the weighted-average coupon on the bonds outstanding was 6.9%. The average effective rate on the bonds was 6.5% and 6.1% for the nine months ended September 30, 2009 and for the year ended December 31, 2008, respectively. The variable-rate bonds pay interest based on one-month LIBOR plus 30 basis points.

NOTE 10 – OBLIGATION UNDER PAYMENT AGREEMENT

Obligation under payment agreement represents the fair value of estimated future payments due to the joint venture discussed in Note 6. The amounts paid under the payment agreement are based on amounts received monthly by the Company on certain securitized commercial mortgage loans pledged to one securitization trust after payment of the associated securitization financing bonds outstanding. At September 30, 2009, the securitized commercial mortgage loans had an unpaid principal balance, including defeased loans, of $144,612, and the associated securitization financing bonds had an unpaid principal balance of $123,741. The securitized commercial mortgage loans were originated principally in 1996 and 1997, and the securitization financing bonds were issued in 1997.

The present value of the payment agreement is determined based on the estimated future payments due to the joint venture discounted at a weighted average rate of 25%. The discount rate was derived based on management’s estimate of the discount rate. Such estimate was derived based on yields observed by broker-dealers on recent sales of similar instruments (though from more recent vintages) and from the implied spread to similar maturity interest rate swaps using the price quoted for the lowest rated tranche of CMBX.1 from the CMBX index managed by Markit. The Markit CMBX index is a synthetic tradeable index referencing a basket of 25 commercial mortgage-backed securities. Factors which significantly impact the valuation of the payment agreement include the credit performance of the underlying securitized mortgage loans, estimated prepayments on the loans and the weighted average discount rate used on the cash flows. The significant assumptions used in calculating the estimated fair value of the obligation under payment agreement are presented in the following table with their respective values as of September 30, 2009 and December 31, 2008.

	September 30, 2009			December 31, 2008
Discount rate		25.0	%		36.5	%
Annual loss rate		1.5	%		0.8	%
Prepayment speed (1)	20% CPY			100% CPY

(1)	CPR with yield maintenance provision. 100% CPY assumes all loans prepay at expiration of their prepayment lock-out period and pay yield maintenance premium. 20% CPY assumes a CPR of 20% per annum on the pool upon expiration of the prepayment lock-out period.

The Company made payments to the joint venture of $416 and $1,217 for the three-month and nine-month periods ended September 30, 2009, respectively, and $403 and $1,207, respectively, for the same periods in 2008 under the payment agreement. All of these payments were recorded as interest expense in the condensed financial statements.

NOTE 11 – FAIR VALUE MEASUREMENTS

Pursuant to ASC 820, Fair Value Measurements and Disclosures, fair value is the exchange price in an orderly transaction, that is not a forced liquidation or distressed sale, between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or liability. ASC 820 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.

The three levels of the valuation hierarchy established by ASC 820 are as follows:

·	Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date. The types of assets and liabilities carried at Level 1 fair value generally are equity securities listed in active markets.

Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life. Fair valued assets and liabilities that are generally included in this category are Agency MBS, which are valued based on the average of multiple dealer quotes that are active in the Agency MBS market.

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Generally, assets and liabilities carried at fair value and included in this category are non-Agency MBS, and the obligation under payment agreement liability.

The Company utilizes fair value measurements at various levels within the hierarchy established by ASC 820 for certain of its assets and liabilities. The following table presents the fair value of the Company’s assets and liabilities at September 30, 2009, segregated by the hierarchy level of the fair value estimate:

			Fair Value Measurements
	Fair Value		Level 1		Level 2		Level 3
Assets:
Agency MBS	$	600,927	$	–	$	600,927	$	–
Non-Agency MBS		6,112		–		–		6,112
Other		139		–		–		139
Total assets carried at fair value	$	607,178	$	–	$	600,927	$	6,251

Liabilities:
Obligation under payment agreement	$	9,095	$	–	$	–	$	9,095
Total liabilities carried at fair value	$	9,095	$	–	$	–	$	9,095

The following tables present the reconciliations of the beginning and ending balances of the Level 3 fair value estimates for the three-month and nine-month periods ended September 30, 2009:

Level 3 Fair Values
	Other Investments						Total assets			Obligation under payment agreement
	Non-Agency MBS			Other			Total assets			Obligation under payment agreement
Balance at June 30, 2009	$	5,813		$	158		$	5,971		$	(8,555	)
Total realized and unrealized gains (losses)
Included in earnings		–			–			–			(540	)
Included in other comprehensive income (loss)		383			(14	)		369			–
Purchases, sales, issuances and other settlements, net		(84	)		(5	)		(89	)		–
Transfers in and/or out of Level 3		–			–			–			–
Balance at September 30, 2009	$	6,112		$	139		$	6,251		$	(9,095	)

Level 3 Fair Values
	Other Investments						Total assets			Obligation under payment agreement
	Non-Agency MBS			Other			Total assets			Obligation under payment agreement
Balance at December 31, 2008	$	6,259		$	211		$	6,470		$	(8,534	)
Total realized and unrealized gains (losses)
Included in earnings		–			–			–			(561	)
Included in other comprehensive income (loss)		199			(31	)		168			–
Purchases, sales, issuances and other settlements, net		(346	)		(41	)		(387	)		–
Transfers in and/or out of Level 3		–			–			–			–
Balance at September 30, 2009	$	6,112		$	139		$	6,251		$	(9,095	)

There were no assets or liabilities which were measured at fair value on a non-recurring basis during the three or nine months ended September 30, 2009.

ASC 825-10, Financial Instruments – Overall requires the disclosure of the estimated fair value of financial instruments. The following table presents the recorded basis and estimated fair values of the Company’s financial instruments as of September 30, 2009 and December 31, 2008:

	September 30, 2009				December 31, 2008
	Recorded Basis		Fair Value		Recorded Basis		Fair Value
Assets:
Agency MBS	$	600,927	$	600,927	$	311,576	$	311,576
Securitized mortgage loans, net		225,731		194,436		243,827		201,252
Investment in joint venture		8,174		8,174		5,655		5,595
Other investments		8,439		8,234		12,735		12,358

Liabilities:
Repurchase agreements		545,761		545,761		274,217		274,217
Securitization financing		148,184		133,294		178,165		153,370
Obligation under payment agreement		9,095		9,095		8,534		8,534

The following table presents certain information for Agency MBS and Non-Agency MBS that were in an unrealized loss position at September 30, 2009 and December 31, 2008.

	September 30, 2009				December 31, 2008
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Unrealized loss position for:
Less than one year:
Agency MBS	$	29,906	$	124	$	98,171	$	853
Non-Agency MBS		20		1		3,719		937
One year or more:
Non-Agency MBS		4,346		989		598		355
	$	34,272	$	1,114	$	102,488	$	2,145

Based on the high credit quality of Agency MBS as well as the real or implicit guarantee by the federal government, the Company does not consider any of the current impairment on Agency MBS to be credit related. Declines in fair value resulting from increases in interest rates for short-duration Agency MBS are generally modest and are normally recovered in a short period of time as the coupon resets to a level more consistent with the current market.

The Company reviews the estimated future cash flows for its Non-Agency MBS to determine whether there has been an adverse change in the cash flows for which an other-than-temporary impairment would be required. Approximately, $4,113 of the Non-Agency MBS in an unrealized loss position at September 30, 2009 are investment grade MBS that were originated during or prior to 1994. Based on the credit rating of these MBS and the seasoning of the mortgage loans collateralizing these bonds, the impairment of these MBS was not determined to be other-than-temporary at September 30, 2009. The estimated cash flows of the remaining Non-Agency MBS were reviewed based on the performance of the underlying mortgage loans collateralizing the MBS as well as projected loss and prepayment rates. Based on that review, there was not an adverse change in the timing or amount of estimated cash flows at September 30, 2009 and the decline in value from the Company’s amortized cost basis was due to higher market discount rates.

NOTE 12 – PREFERRED AND COMMON STOCK

The following table presents the preferred and common dividends declared from January 1, 2009 through September 30, 2009:

			Dividend per Share
Declaration Date	Record Date	Payment Date	Common		Preferred
March 20, 2009	March 31, 2009	April 30, 2009		0.2300		0.2375
June 16, 2009	June 30, 2009	July 31, 2009		0.2300		0.2375
September 15, 2009	September 30, 2009	October 30, 2009		0.2300		0.2375

Shelf Registration

On February 29, 2008, the Company filed a shelf registration statement on Form S-3, which became effective on April 17, 2008. The shelf registration permits the Company to sell up to $1.0 billion of securities, including common stock, preferred stock, debt securities and warrants.

Controlled Equity Offering Program

The Company initiated a controlled equity offering program (“CEOP”) on March 16, 2009 by filing a prospectus supplement under its shelf registration. The CEOP allows the Company to offer and sell, from time to time through Cantor Fitzgerald & Co. (“Cantor”) as agent, up to 3,000,000 shares of its common stock in negotiated transactions or transactions that are deemed to be “at the market offerings”, as defined in Rule 415 under the Securities Act of 1933, as amended, including sales made directly on the New York Stock Exchange or sales made to or through a market maker other than on an exchange.

During the nine months ended September 30, 2009, the Company sold 1,392,250 shares of its common stock through the CEOP at an average price of $7.10 per share, for which it received proceeds of $9,884, net of sales commission paid to Cantor. After this transaction, 1,607,750 shares of the Company’s common stock remain available for offer and sale under the CEOP.

The following table presents the changes in the number of preferred and common shares outstanding during the nine months ended September 30, 2009:

	Preferred
	Series D		Common
December 31, 2008		4,221,539		12,169,762
Issuance of shares under the CEOP		-		1,392,250
Restricted shares granted (see Note 14)		-		10,000
September 30, 2009		4,221,539		13,572,012

NOTE 13 – COMMITMENTS AND CONTINGENCIES

The Company and its subsidiaries may be involved in certain litigation matters arising in the ordinary course of business from time to time. Although the ultimate outcome of these matters cannot be ascertained at this time, and the results of legal proceedings cannot be predicted with certainty, the Company believes, based on current knowledge, that the resolution of these matters will not have a material adverse effect on the Company’s financial position or results of operations. The following information relates to litigation not arising in the ordinary course of business.

As noted in prior filings, one of the Company’s subsidiaries, GLS Capital, Inc. (“GLS”), and the County of Allegheny, Pennsylvania are defendants in a class action lawsuit filed in 1997 in the Court of Common Pleas of Allegheny County, Pennsylvania (the "Court of Common Pleas"). Class action status has been certified in this matter, but a motion to reconsider is pending. In June 2009, the Court of Common Pleas held a hearing on the status of the legal claims of the plaintiffs primarily as a result of an opinion issued in August 2008 by the Pennsylvania Supreme Court in unrelated litigation which addressed many of the claims in this matter and which opinion was favorable to GLS relative to claims being made by the plaintiffs. As a result of that hearing, the Court of Common Pleas invited GLS to file a motion for summary judgment and scheduled argument on such motion for November 2009. The plaintiffs have not enumerated their damages in this matter, and the Company believes that the ultimate outcome of this litigation will not have a material impact on its financial condition, but may have a material impact on its reported results for a given year or period.

Dynex Capital, Inc. and Dynex Commercial, Inc. (“DCI”), a former affiliate of the Company and now known as DCI Commercial, Inc., are appellees (or respondents) in the Court of Appeals for the Fifth Judicial District of Texas at Dallas, related to the matter of Basic Capital Management et al. (collectively, “BCM” or the “Plaintiffs”) versus DCI et al. as previously discussed by the Company in prior filings. There has been no material change in this litigation from what was disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed on March 16, 2009.

Dynex Capital, Inc., MERIT Securities Corporation, a subsidiary (“MERIT”), and the former president and current Chief Operating Officer and Chief Financial Officer of Dynex Capital, Inc., (together, “Defendants”) are defendants in a putative class action complaint alleging violations of the federal securities laws in the United States District Court for the Southern District of New York (“District Court”) by the Teamsters Local 445 Freight Division Pension Fund (“Teamsters”), as previously discussed in prior filings. The complaint was filed on February 7, 2005 and a second amended complaint was originally filed on August 6, 2008. The second amended complaint seeks unspecified damages and alleges, among other things, misrepresentations in connection with the issuance of and subsequent reporting on certain securitization financing bonds issued by MERIT in 1998 and 1999. On October 19, 2009, the District Court substantially denied the Defendants’ motion to dismiss the second amended complaint. The Company has evaluated the allegations made in the complaint and believes them to be without merit and intends to vigorously defend itself against them.

Although no assurance can be given with respect to the ultimate outcome of these matters, the Company believes the resolution of these matters will not have a material effect on its financial condition but could materially affect its reported results for a given year or period.

NOTE 14 – STOCK BASED COMPENSATION

Pursuant to the Company’s 2009 Stock and Incentive Plan, as approved by the shareholders at the Company’s 2009 annual shareholders’ meeting (the “2009 Stock and Incentive Plan”), the Company may grant to eligible employees, directors or consultants or advisors to the Company stock based compensation, including stock options, stock appreciation rights (“SARs”), stock awards, dividend equivalent rights, performance shares, and stock units. A total of 2,500,000 shares of common stock is available for issuance pursuant to the 2009 Stock and Incentive Plan.

The Company also has a 2004 Stock Incentive Plan, as approved by the Company’s shareholders at its 2005 annual shareholders’ meeting (the “2004 Stock Incentive Plan”) under which it made awards to its employees and directors prior to 2009. The 2004 Stock Incentive Plan covers only those awards made prior to 2009, and no new awards will be made under this plan.

On May 15, 2009, the Company granted 10,000 shares of restricted stock to its non-employee directors under the 2009 Stock and Incentive Plan. The awards vest, subject to exceptions for death, disability or retirement, on May 14, 2010. Subject to exceptions for death, disability or retirement, any directors that separate from the board prior to vesting forfeit their restricted stock. The fair value of the restricted stock on the grant date was $7.47 per share for a total deferred compensation cost of $75, which will be recognized in expense evenly over the vesting period.

The following table presents a summary of the activity for the SARs issued by the Company for the following periods:

	Three Months Ended				Nine Months Ended
	September 30, 2009				September 30, 2009
	Number of Shares		Weighted-Average Exercise Price		Number of Shares		Weighted- Average Exercise Price
SARs outstanding at beginning of period		278,146	$	7.27		278,146	$	7.27
SARs granted		–		–		–		–
SARs forfeited or redeemed		–		–		–		–
SARs exercised		–		–		–		–
SARs outstanding at end of period		278,146	$	7.27		278,146	$	7.27
SARs vested and exercisable		219,396	$	7.37		219,396	$	7.37

The following table presents a summary of the activity for the stock options issued by the Company for the following periods:

Three Months Ended

Nine Months Ended

September 30, 2009