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 March 31, 2010

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 April 30, 2010, the registrant had 15,118,742 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

		Consolidated Balance Sheets as of March 31, 2010 (unaudited) and December 31, 2009	1

		Consolidated Statements of Income for the three months ended March 31, 2010 and March 31, 2009 (unaudited)	2

		Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2010 (unaudited)	3

		Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and March 31, 2009 (unaudited)	4

		Consolidated Statements of Comprehensive Income for the three months ended March 31, 2010 and March 31, 2009 (unaudited)	5

		Condensed Notes to Unaudited Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	44

	Item 4.	Controls and Procedures	50

PART II.	OTHER INFORMATION

	Item 1.	Legal Proceedings	51

	Item 1A.	Risk Factors	52

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52

	Item 3.	Defaults Upon Senior Securities	52

	Item 4.	(Removed and Reserved)	52

	Item 5.	Other Information	52

	Item 6.	Exhibits	53

SIGNATURES			54

PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

DYNEX CAPITAL, INC.

CONSOLIDATED BALANCE SHEETS

(amounts in thousands except share data)

	March 31, 2010			December 31, 2009
	(unaudited)
ASSETS
Agency MBS (including pledged of $539,276 and $575,386, respectively)	$	558,935		$	594,120
Non-Agency securities (including pledged of $175,492 and $82,770, respectively)		188,737			109,110
Securitized mortgage loans, net		204,609			212,471
Other investments, net		2,156			2,280
		954,437			917,981

Cash and cash equivalents		30,714			30,173
Derivative assets		–			1,008
Accrued interest receivable		4,270			4,583
Other assets, net		5,037			4,317
	$	994,458		$	958,062
LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities:
Repurchase agreements	$	602,451		$	638,329
Non-recourse collateralized financing		201,506			143,081
Derivative liabilities		187			–
Accrued interest payable		1,162			1,208
Other liabilities		5,508			6,691
		810,814			789,309

Commitments and Contingencies (Note 13)

Shareholders’ equity:
Preferred stock, par value $.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 $.01 per share, 100,000,000 shares authorized; 15,037,802 and 13,931,512 shares issued and outstanding, respectively		150			139
Additional paid-in capital		389,459			379,717
Accumulated other comprehensive income		14,112			10,061
Accumulated deficit		(261,826	)		(262,913	)
		183,644			168,753
	$	994,458		$	958,062

See condensed notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(amounts in thousands except per share data)

	Three Months Ended
	March 31,
	2010			2009
Interest income:
Agency MBS	$	4,868		$	4,435
Non-Agency securities		2,501			159
Securitized mortgage loans		3,623			4,820
Other investments		32			58
Cash and cash equivalents		3			5
		11,027			9,477
Interest expense:
Repurchase agreements		1,263			1,064
Non-recourse collateralized financing		2,567			2,975
Other interest expense		–			394
		3,830			4,433

Net interest income		7,197			5,044
Provision for loan losses		(409	)		(179	)
Net interest income after provision for loan losses		6,788			4,865

Gain on sale of investments, net		77			83
Fair value adjustments, net		82			645
Other income, net		669			21
Equity in loss of joint venture, net		–			(754	)
General and administrative expenses:
Compensation and benefits		(972	)		(883	)
Other general and administrative expenses		(1,107	)		(843	)

Net income		5,537			3,134
Preferred stock dividends		(1,003	)		(1,003	)

Net income to common shareholders	$	4,534		$	2,131

Weighted average common shares:
Basic		14,210			12,170
Diluted		18,437			12,170
Net income per common share:
Basic	$	0.32		$	0.18
Diluted	$	0.30		$	0.18

Dividends declared per common share	$	0.23		$	0.23

See condensed notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

(amounts in thousands)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive Income		Accumulated Deficit			Total
Balance as of December 31, 2009	$	41,749	$	139	$	379,717	$	10,061	$	(262,913	)	$	168,753
Common stock issuance		–		11		9,707		–		–			9,718
Restricted stock vesting		–		–		35		–		–			35
Cumulative effect of adoption of new accounting principle		–		–		–		–		12			12
Net income		–		–		–		–		5,537			5,537
Dividends on preferred stock		–		–		–		–		(1,003	)		(1,003	)
Dividends on common stock		–		–		–		–		(3,459	)		(3,459	)
Other comprehensive income		–		–		–		4,051		–			4,051
Balance as of March 31, 2010	$	41,749	$	150	$	389,459	$	14,112	$	(261,826	)	$	183,644

See condensed notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(amounts in thousands)

	Three Months Ended
	March 31,
	2010			2009
Operating activities:
Net income	$	5,537		$	3,134
Adjustments to reconcile net income to cash provided by operating activities:
Equity in loss of joint venture, net		–			754
Decrease (increase) in accrued interest receivable		313			(823	)
Decrease in accrued interest payable		(46	)		(333	)
Provision for loan losses		409			179
Gain on sale of investments, net		(77	)		(83	)
Fair value adjustments, net		(82	)		(645	)
Amortization and depreciation		1,570			436
Stock based compensation expense		58			67
Net change in other assets and other liabilities		(2,078	)		(184	)
Net cash and cash equivalents provided by operating activities		5,604			2,502

Investing activities:
Purchase of investments		(100,431	)		(153,951	)
Payments received on investments		59,296			18,169
Proceeds from sales of investments		31,405			1,860
Principal payments received on securitized mortgage loans		7,770			5,089
Other investing activities		(16,743	)		(549	)
Net cash and cash equivalents used in investing activities		(18,703	)		(129,382	)

Financing activities:
(Repayment of) borrowings under repurchase agreements, net		(35,878	)		128,928
Proceeds from non-recourse collateralized financing		50,678			–
Principal payments on non-recourse collateralized financing		(6,406	)		(3,714	)
Decrease in restricted cash		–			2,974
Proceeds from issuance of common stock		9,453			–
Dividends paid		(4,207	)		(3,802	)
Net cash and cash equivalents provided by financing activities		13,640			124,386


Net increase (decrease) in cash and cash equivalents		541			(2,494	)
Cash and cash equivalents at beginning of period		30,173			24,335
Cash and cash equivalents at end of period	$	30,714		$	21,841

Supplemental Non-Cash Investing and Financing Activities:
Common dividends declared but not paid	$	3,459		$	2,799
Preferred dividends declared but not paid	$	1,003		$	1,003

See condensed notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(amounts in thousands)

	Three Months Ended
	March 31,
	2010			2009

Net income	$	5,537		$	3,134
Other comprehensive income:
Available-for-sale securities:
Change in market value		5,313			3,553
Reclassification adjustment for net gain on sale of investments		(77	)		(83	)
Reclassification adjustment for equity in the joint venture’s other-than-temporary impairment		–			707
Net unrealized loss on cash flow hedge liabilities		(1,185	)		–
		4,051			4,177

Comprehensive income		9,588			7,311
Dividends declared on preferred stock		(1,003	)		(1,003	)

Comprehensive income to common shareholders	$	8,585		$	6,308

See condensed notes to unaudited consolidated financial statements.

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DYNEX CAPITAL, INC.

(amounts in thousands except share and per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements of Dynex Capital, Inc. and its qualified real estate investment trust (“REIT”) subsidiaries and its taxable REIT subsidiary (together, “Dynex” or the “Company”) have been prepared in accordance with the instructions to the Quarterly Report on 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. In the opinion of management, all significant adjustments, consisting of normal recurring accruals considered necessary for a fair presentation of the consolidated financial statements, have been included. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for any other interim periods or for the entire year ending December 31, 2010. The unaudited 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, 2009, filed with the SEC.

Certain items in the prior year’s consolidated financial statements have been reclassified to conform to the current year’s presentation. The Company’s consolidated statements of cash flows now present separately its changes in accrued interest receivable and accrued interest payable, which were previously included within its net change in other assets and other liabilities as well as within principal payments received on securitized mortgage loans and principal payments on securitization financing. These respective amounts on the consolidated statement of cash flows for the three months ended March 31, 2009 presented herein have been reclassified to conform to the current year presentation and have no effect on reported total assets or total liabilities or results of operations.

Consolidation of Subsidiaries

The consolidated financial statements include the accounts of the Company, its qualified REIT subsidiaries and its taxable REIT subsidiary. The consolidated financial statements represent the Company’s accounts after the elimination of intercompany balances and transactions. 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”) Topic 810. The Company follows the equity method of accounting for investments with greater than a 20% and less than 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 the disclosure of contingent assets and liabilities at the date of the financial statements as well as 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 fair value measurements of its investments, allowance for loan losses, other-than-temporary impairments, commitments and contingencies, and amortization of premiums and discounts. These items are discussed further below within this note to the consolidated financial statements.

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 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”), non-Agency securities, securitized mortgage loans, and other investments.

Agency MBS. Agency MBS are comprised of residential mortgage backed securities (“RMBS”) and commercial mortgage backed securities (“CMBS”) 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 which are loans that have a fixed rate of interest for a specified period (typically three to ten years) and which then adjust their interest rate 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 which have interest rates that generally will adjust at least annually to an increment over a specified interest rate index. Agency ARMs also include Hybrid Agency ARMs that are past their fixed rate periods.

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 loans will typically have interim and lifetime caps on interest rate adjustments, or interest rate caps, limiting the amount that the rates on these loans may reset in any given period.

The Company accounts for its Agency MBS in accordance with ASC Topic 320, which requires that investments in debt and equity securities be designated as either “held-to-maturity,” “available-for-sale” or “trading” at the time of acquisition. All of the Company’s securities are designated as available-for-sale with changes in their fair value reported in other comprehensive income until the security is collected, disposed of, or determined to be other than temporarily impaired. The Company determines the fair value of its investment securities based upon prices obtained from a third-party pricing service and broker quotes. Although the Company generally intends to hold its investment securities until maturity, it may, from time to time, sell any of its securities as part of the overall management of its business. The available-for-sale designation provides the Company with the flexibility to sell any of its investment securities. Upon the sale of an investment security, any unrealized gain or loss is reclassified out of accumulated other comprehensive income (“AOCI”) to earnings as a realized gain or loss using the specific identification method.

Substantially all of the Company’s Agency MBS are pledged as collateral against repurchase agreements.

Non-Agency Securities. The Company’s non-Agency securities are comprised of CMBS and RMBS, the majority of which are investment grade rated. The Company accounts for its non-Agency securities in accordance with ASC Topic 320, which requires that investments in debt and equity securities be designated as either “held-to-maturity,” “available-for-sale” or “trading” at the time of acquisition. All of the Company’s non-Agency securities are designated as available-for-sale with changes in their fair value reported in other comprehensive income until the security is collected, disposed of, or determined to be other than temporarily impaired.

The Company determines the fair value for certain of its non-Agency securities based upon prices obtained from a third-party pricing service and broker quotes with the remainder of the non-Agency securities being valued by discounting the estimated future cash flows derived from pricing models that utilize information such as the security’s coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected losses, credit enhancement, as well as certain other relevant information. Although the Company generally intends to hold its investment securities until maturity, it may, from time to time, sell any of its securities as part of the overall management of its business. The available-for-sale designation provides the Company with the flexibility to sell any of its investment securities. Upon the sale of an investment security, any unrealized gain or loss is reclassified out of AOCI to earnings as a realized gain or loss using the specific identification method.

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.

Other Investments. Other investments include unsecuritized single-family and commercial mortgage loans which are carried at amortized cost.

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 for these types of loans.

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 Topic 860 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.

Securitization Transactions

The Company has securitized mortgage loans through securitization transactions by transferring financial assets to a wholly owned trust, where the trust issues non-recourse securitization financing bonds pursuant to an indenture. The Company retains some form of control over the transferred assets, and therefore the trust is included in the consolidated financial statements of the Company. For accounting and tax purposes, the loans and securities financed through the issuance of bonds in a securitization financing transaction are treated as assets of the Company (presented as securitized mortgage loans on the balance sheet), and the associated bonds issued are treated as debt of the Company (presented as a portion of non-recourse collateralized financing on the balance sheet). The Company has retained certain of the bonds issued by the trust and has transferred collateral in excess of the bonds issued. This excess is typically referred to as over-collateralization. Each securitization trust generally provides the Company the right to redeem, at its option, the remaining outstanding bonds prior to their maturity date.

In December 2009, the Company re-securitized a portion of its CMBS and sold $15,000 of bonds to a special purpose entity which is not included in the consolidated financial statements of the Company as of or for the year ended December 31, 2009, but is included in the consolidated financial statements as of and for the three months ended March 31, 2010 as required by amendments to ASC Topic 860 which became effective January 1, 2010. Please refer to the “Recent Accounting Pronouncements” section contained within this note for information related to the change in accounting principle for these bonds.

Derivative Instruments

The Company may enter into interest rate swap agreements, interest rate cap agreements, interest rate floor agreements, financial forwards, financial futures and options on financial futures (“interest rate agreements”) to manage its sensitivity to changes in interest rates. These interest rate agreements are intended to offset potentially reduced net interest income and cash flow under certain interest rate environments. The Company accounts for its interest rate agreements under ASC Topic 815, designating each as either hedge positions or trading positions using criteria established therein. In order to qualify as a cash flow hedge, ASC Topic 815 requires formal documentation to be prepared at the inception of the interest rate agreement. This formal documentation must describe the risk being hedged, identify the hedging instrument and the means to be used for assessing the effectiveness of the hedge, and demonstrate that the hedging instrument will be highly effective at hedging the risk exposure. If these conditions are not met, an interest rate agreement will be classified as a trading position.

For interest rate agreements designated as cash flow hedges, the Company evaluates the effectiveness of these hedges against the financial instrument being hedged. The effective portion of the hedge relationship on an interest rate agreement designated as a cash flow hedge is reported in AOCI and is later reclassified into the statement of income in the same period during which the hedged transaction affects earnings. The ineffective portion of such hedge is immediately reported in the current period’s statement of income. These derivative instruments are carried at fair value on the Company’s balance sheet in accordance with ASC Topic 815. Cash posted to meet margin calls, if any, is included on the consolidated balance sheets in other assets.

The Company may be required periodically to terminate hedging instruments. Any basis adjustments or changes in the fair value of hedges recorded in other comprehensive income are recognized into income or expense in conjunction with the original hedge or hedged exposure.

If the underlying asset, liability or commitment is sold or matures, the hedge is deemed partially or wholly ineffective, or if the criterion that was executed at the time the hedging instrument was entered into no longer exists, the interest rate agreement no longer qualifies as a designated hedge. Under these circumstances, such changes in the market value of the interest rate agreement are recognized in current period’s statement of income.

For interest rate agreements designated as trading positions, realized and unrealized changes in fair value of these instruments are recognized in the statement of income as trading income or loss in the period in which the changes occur or when such trade instruments are settled. As of March 31, 2010 and December 31, 2009, the Company does not have any derivative instruments designated as trading positions.

Interest Income

Interest income on securities and loans that are rated “AAA” is recognized over the contractual life of the investment using the effective interest method. Interest income on non-Agency securities that are rated “AA” or lower is recognized over the expected life as adjusted for estimated prepayments and credit losses of the securities in accordance with ASC Topic 325.

For loans, 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 loan is significantly past due or when the primary servicer of the loan fails to advance the interest and/or principal due on the loan. Loans are considered past due when the borrower fails to make a timely payment in accordance with the underlying loan agreement. 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. All interest accrued but not collected for investments that are placed on a 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, and Deferred Issuance Costs

Premiums and discounts on investments and obligations, as well as debt issuance costs and hedging basis adjustments, are amortized into interest income or expense, respectively, over the contractual life of the related investment or obligation using the effective interest method in accordance with ASC Topic 310 and ASC Topic 470. For securities representing beneficial interests in securitizations that are not highly rated, unamortized premiums and discounts are recognized over the expected life, as adjusted for estimated prepayments and credit losses of the securities, in accordance with ASC Topic 325. Actual prepayment and credit loss experience are reviewed, and effective yields are recalculated when originally anticipated prepayments and credit losses differ from amounts actually received plus anticipated future prepayments.

Other-than-Temporary Impairments

The Company evaluates all debt securities in its investment portfolio for other-than-temporary impairments by applying the guidance prescribed in ASC Topic 320 in determining whether an other-than-temporary impairment has occurred. A debt 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 Company intends, or is required, to sell the security before recovery of the security’s amortized cost basis. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. Any remaining difference between fair value and amortized cost is recognized in other comprehensive income. 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 delinquent mortgage loans in the security.

Contingencies

In the normal course of business, there are various lawsuits, claims, and contingencies pending against the Company. In accordance with ASC Topic 450, we evaluate whether to establish provisions for estimated losses from pending claims, investigations and proceedings. Although the ultimate outcome of the various matters cannot be ascertained at this point, it is the opinion of management, after consultation with counsel, that the resolution of the foregoing matters will not have a material adverse effect on the financial condition of the Company, taken as a whole. Such resolution may, however, have a material effect on the results of operations or cash flows in any future period, depending on the level of income for such period.

Recent Accounting Pronouncements

In December 2009, Accounting Standards Update (“ASU” or “Update”) No. 2009-16, Transfers and Servicing (Topic 860)-Accounting for Transfers of Financial Assets and ASU No. 2009-17, Consolidations (Topic 810)-Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities were issued as amendments to the ASC. The purpose of the amendment to ASC Topic 860 is to eliminate the concept of a “qualifying special-purpose entity” (“QSPE”) and to require 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. The purpose of the amendment to ASC Topic 810 is to change how a reporting entity determines when to consolidate another entity that is insufficiently capitalized or is not controlled by voting rights. Instead of focusing on quantitative determinants, consolidation is to be determined based on, among other things, qualitative factors such as the other entity’s purpose and design as well as the reporting entity’s ability to direct the activities of the other entity that most significantly impact its performance. The reporting entity is also required to add significant disclosures regarding its involvement with variable interest entities and any changes in risk exposure due to this involvement. Both of these amendments to the Codification are effective for transactions and events occurring after the beginning of a reporting entity’s first fiscal year that begins after November 15, 2009, and are to be prospectively applied. The Company had one QSPE that it consolidated as a result of the adoption of these standards on January 1, 2010. As a result, the company recorded a gain of $12 for a cumulative effect of adoption of new accounting principle to its retained earnings as of January 1, 2010. The Company’s investments and related securitization financing as of January 1, 2010 also increased by approximately $14,924 as a result of these amendments to the ASC.

Subsequently, in February 2010, ASU No. 2010-10 was issued, which allows certain reporting entities to defer the consolidation requirements amended in ASC Topic 810 by ASU No. 2009-17. The Company is not eligible for this deferral.

In January 2010, FASB issued Update No. 2010-01 which amends the accounting guidance specified in ASC Topic 505. Specifically, the amendment clarifies that the stock portion of a distribution to stockholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all stockholders can elect to receive in the aggregate is considered a share issuance that is reflected in earnings per share prospectively and is not a stock dividend. This Update is effective for interim and annual reporting periods ending on or after December 15, 2009, and should be applied retrospectively. The Company has only distributed cash dividends to its stockholders, and does not currently intend to change this policy. As such, this amendment to ASC Topic 505 did not have and is not expected to have a material impact on the Company’s financial condition or results of operations.

In January 2010, FASB issued Update No. 2010-06, which amends ASC Topic 820 to require additional disclosures and to clarify existing disclosures. Specifically, entities will be required to disclose reasons for and amounts of transfers in and out of levels 1 and 2 as well as a reconciliation of level 3 measurements to include separate information about purchases, sales, issuances, and settlements. Additionally, this amendment clarifies that a “class” of assets or liabilities is often a subset of assets or liabilities within a line item on the entity’s balance sheet, and that a reporting entity should provide fair value measurement disclosures for each class. This amendment also clarifies that disclosures about valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements is required for those measurements that fall in either level 2 or 3. The effective date for the new disclosure requirements relating to the rollforward of activity in level 3 fair value measurements is for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. All other new disclosures and clarifications of existing disclosures issued in this Update are effective for interim and annual reporting periods beginning after December 15, 2009. Management has complied with these new disclosure requirements within this Quarterly Report on Form 10-Q. Because these amendments to ASC Topic 820 relate only to disclosures and do not alter GAAP, they do not impact the Company’s financial condition or results of operations.

In April 2010, FASB issued ASU No. 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset. This ASU codifies the consensus reached in EITF Issue No. 09-I, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset.” The amendments to the FASB Accounting Standards Codification™ (Codification) provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool

change. ASU 2010-18 does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.

ASU 2010-18 is effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted. Upon initial adoption of ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration.

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:

	Three Months Ended March 31,
	2010					2009
	Income			Weighted-Average Common Shares		Income			Weighted- Average Common Shares
Net income	$	5,537				$	3,134
Preferred stock dividends		(1,003	)				(1,003	)
Net income to common shareholders		4,534			14,210		2,131			12,170
Effect of dilutive items		1,003			4,228		–			–
Diluted	$	5,537			18,437	$	2,131			12,170

Net income per common share:
Basic				$	0.32				$	0.18
Diluted				$	0.30				$	0.18

Components of dilutive items:
Convertible preferred stock	$	1,003			4,222		–			–
Stock options		–			6		–			–
	$	1,003			4,228	$	–			–

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

	Three Months Ended March 31,
	2010		2009
Shares issuable under stock option awards		40		110
Convertible preferred stock		–		4,222

NOTE 3 – AGENCY MORTGAGE BACKED SECURITIES

The following table presents the components of the Company’s investment in Agency MBS as of March 31, 2010 and December 31, 2009:

	March 31, 2010			December 31, 2009
Principal/par value	$	537,492		$	570,215
Purchase premiums		12,000			12,991
Purchase discounts		(38	)		(44	)
Amortized cost		549,454			583,162
Gross unrealized gains		9,696			11,261
Gross unrealized losses		(215	)		(303	)
Fair value	$	558,935		$	594,120

Weighted average coupon		4.63	%		4.76	%
Weighted average months to reset	18 months			20 months

Principal/par value includes principal payments receivable on Agency MBS of $20,127 and $3,559 as of March 31, 2010 and December 31, 2009, respectively, which increased primarily due to the buyout in March 2010 by Freddie Mac of mortgage loans collateralizing its MBS that were delinquent 120 or more days. The Company’s investment in Agency MBS as of March 31, 2010 is comprised of $253,867 of Hybrid Agency ARMs, $302,109 of Agency ARMs, and $2,959 of fixed-rate Agency MBS. The Company received principal payments of $56,304 on its portfolio of Agency MBS and purchased approximately $7,353 of Agency MBS during the three months ended March 31, 2010. The Company’s investment in Agency MBS as of December 31, 2009 was comprised of $295,730 of Hybrid Agency ARMs, $298,259 of Agency ARMs, and $131 of fixed-rate Agency MBS. The Company received principal payments of $17,946 on its portfolio of Agency MBS and purchased approximately $153,951 of Agency MBS during the three months ended March 31, 2009.

NOTE 4 – NON-AGENCY SECURITIES

The following table presents the components of the Company’s non-Agency securities as of March 31, 2010 and December 31, 2009:

	March 31, 2010									December 31, 2009
	CMBS			RMBS			Total Non-Agency			CMBS			RMBS			Total Non-Agency
Carrying value	$	178,226		$	5,702		$	183,928		$	104,553		$	6,462		$	111,015
Gross unrealized gains		5,596			314			5,910			2,795			415			3,211
Gross unrealized losses		(216	)		(885	)		(1,101	)		(4,145	)		(971	)		(5,116	)
	$	183,606		$	5,131		$	188,737		$	103,203		$	5,907		$	109,110
Weighted average coupon		6.69	%		7.51	%		6.72	%		7.96	%		7.93	%		7.96	%

The Company’s non-Agency CMBS are comprised primarily of ‘AAA’-rated securities with a fair value of $179,518 and $99,092, as of March 31, 2010 and December 31, 2009, respectively. The Company purchased non-Agency CMBS with a par value of $60,800 during the three months ended March 31, 2010 which have a fair value of $61,584 as of March 31, 2010. The majority of the Company’s non-Agency RMBS were issued by a single trust in 1994. The Company did not purchase any additional non-Agency RMBS during the three months ended March 31, 2010.

In 2009, the Company exercised certain of its redemption rights and redeemed CMBS that were refinanced through a securitization transaction in December 2009. The Company sold $15,000 of the securitization bonds as part of this transaction. As a result of the adoption of the amendments to ASC Topics 860 and 810 on January 1, 2010 discussed previously in the “Recent Accounting Pronouncements” section of Note 1, the Company now consolidates these assets and the associated securitization financing. This resulted in an increase to the par value of the Company’s investments as of January 1, 2010 of $15,000 with a corresponding increase in the par value of its securitization financing.

NOTE 5 – SECURITIZED MORTGAGE LOANS, NET

The following table summarizes the components of securitized mortgage loans as of March 31, 2010 and December 31, 2009:

	March 31, 2010			December 31, 2009
Securitized mortgage loans:
Commercial	$	121,346		$	137,567
Single-family		59,853			61,336
		181,199			198,903
Funds held by trustees, including funds held for defeasance		27,671			17,737
Unamortized discounts and premiums, net		101			43
Loans, at amortized cost		208,971			216,683
Allowance for loan losses		(4,362	)		(4,212	)
	$	204,609		$	212,471

All of the securitized mortgage loans are encumbered by securitization financing bonds, which are discussed further in Note 9.

Commercial mortgage loans were originated principally in 1996 and 1997 and are collateralized by first deeds of trust on income producing properties. Approximately 83% of commercial mortgage loans are secured by multifamily properties and approximately 17% by other types of commercial properties.

Single-family mortgage loans are secured by first deeds of trust on residential real estate and were originated principally from 1992 to 1997. Single-family mortgage loans at March 31, 2010 includes $1,300 of loans in foreclosure and $1,457 of loans more than 90 days delinquent on which the Company continues to accrue interest.

The Company identified $19,691 of securitized commercial mortgage loans and $3,309 of securitized single-family mortgage loans as being impaired as of March 31, 2010, compared to impairments of $20,491 and $4,065, respectively, as of December 31, 2009. The Company recognized $260 of interest income on impaired securitized commercial mortgage loans and $51 on impaired single-family mortgage loans for the three months ended March 31, 2010.

Funds held by trustees as of March 31, 2010 and December 31, 2009 include $27,522 and $17,588, respectively, of cash and cash equivalents held by the trust for defeased loans. These defeased funds represent replacement collateral for the defeased mortgage loan, which replicates the contractual cash flows of the defeased mortgage loan and will be used to service the debt for which the underlying mortgage on the property has been released.

NOTE 6 – ALLOWANCE FOR LOAN LOSSES

The following table presents the components of the allowance for loan losses as of March 31, 2010 and December 31, 2009:

	March 31, 2010		December 31, 2009
Securitized commercial mortgage loans	$	4,085	$	3,935
Securitized single-family mortgage loans		277		277
		4,362		4,212
Other investments		355		96
	$	4,717	$	4,308

The following table presents certain information on impaired single-family and commercial securitized mortgage loans as of March 31, 2010 and December 31, 2009:

	March 31, 2010						December 31, 2009
	Commercial			Single-family			Commercial			Single-family
Investment in impaired loans	$	19,591		$	3,365		$	20,465		$	4,152
Allowance for loan losses		(4,085	)		( 277	)		(3,935	)		(277	)
Investment in excess of allowance	$	15,506		$	3,088		$	16,530		$	3,875

The following table summarizes the aggregate activity for the allowance for loan losses for the three months ended March 31, 2010 and March 31, 2009:

	Three Months Ended March 31,
	2010		2009
Allowance at beginning of period	$	4,308	$	3,707
Provision for loan losses		409		179
Credit losses, net of recoveries		–		(9	)
Allowance at end of period	$	4,717	$	3,877

NOTE 7 – DERIVATIVES

Please see Note 1 for additional information related to the Company’s accounting policies for derivative instruments.

The table below presents the fair value of the Company’s derivative financial instruments designated as hedging instruments under ASC Topic 815 as well as their classification on the balance sheet as of March 31, 2010 and December 31, 2009:

Type of Derivative	Balance Sheet Location	Gross Fair Value As of March 31, 2010			Gross Fair Value As of December 31, 2009
Interest rate swaps	Derivative assets	$	–		$	1,008
Interest rate swaps	Derivative liabilities		(187	)		–
		$	(187	)	$	1,008

The Company’s objective for using interest rate swaps is to minimize its exposure to the risk of increased interest expense resulting from its existing and forecasted short-term, fixed-rate borrowings. The Company continuously borrows funds via sequential fixed-rate, short-term repurchase agreement borrowings. As each fixed-rate repurchase agreement matures, it is replaced with new fixed-rate agreements based on the market interest rate in effect at the time of such replacement. This sequential rollover borrowing program creates a variable interest expense pattern. The changes in the cash flows of the interest rate swaps listed above are expected to be highly effective at offsetting changes in the interest portion of the cash flows expected to be paid at maturity of each borrowing.

The following table summarizes information regarding the Company’s outstanding interest rate swap agreements as of March 31, 2010:

Effective Date	Maturity Date	Notional Amount	Fixed Rate Swapped
November 24, 2009	November 24, 2011	$ 25,000	0.96%
November 24, 2009	November 24, 2012	$ 50,000	1.53%
December 24, 2009	December 24, 2014	$ 30,000	2.50%
February 8, 2010	February 8, 2012	$ 75,000	1.03%

These interest rate swaps have been designated as cash flow hedging positions. The Company did not have derivative instruments designated as trading positions as of March 31, 2010 or December 31, 2009. As of March 31, 2010, the Company had margin requirements for these interest rate swaps totaling $944 for which Agency MBS with a fair value of $715 and cash of $229 have been posted as collateral.

The Company has a cumulative unrealized loss of $(177) in accumulated other comprehensive income as of March 31, 2010, compared to a cumulative unrealized gain of $1,008 as of December 31, 2009 for the fair value of the Company’s interest rate swaps. Amounts reported in other comprehensive income related to cash flow hedging instruments are reclassified to the statement of income as interest payments are made on the Company’s variable rate debt. The Company records any income or expense resulting from the ineffective portions of its interest rate swaps in its statement of income in the period incurred.

The table below presents the effect of the Company’s derivatives designated as hedging instruments on the statement of income for the three months ended March 31, 2010. The Company did not hold any derivative financial instruments during the three months ended March 31, 2009.

Type of Derivative Designated as Cash Flow Hedge	Amount of Loss Recognized in OCI on Derivative (Effective Portion), net of $0 tax	Location of Loss Reclassified from OCI into Statement of Income (Effective Portion)	Amount of Loss Reclassified from OCI into Statement of Income (Effective Portion)	Location of Loss Recognized in Statement of Income on Derivative (Ineffective Portion)	Amount of Loss Recognized in Statement of Income on Derivatives (Ineffective Portion)
Interest rate swaps	$ 1,638	Interest expense	$ 453	Other income, net	$ 10

The Company estimates that an additional $1,588 will be reclassified to earnings from AOCI as an increase to interest expense during the next 12 months.

The interest rate agreements the Company has with its derivative counterparties contain various covenants related to the Company’s credit risk. Specifically, if the Company defaults on any of its indebtedness, including those circumstances whereby repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default of its derivative obligations. Additionally, the agreements outstanding with one of the derivative counterparties allow that counterparty to require settlement of its outstanding derivative transactions if the Company fails to earn GAAP net income greater than $1 as measured on a rolling two quarter basis. These interest rate agreements also contain provisions whereby, if the Company fails to maintain a minimum net amount of shareholders’ equity, then the Company may be declared in default on its derivative obligations. As of March 31, 2010, the Company had derivatives in a net liability position totaling $215, inclusive of accrued interest but excluding any adjustment for nonperformance risk. If the Company had breached any of these agreements as of March 31, 2010, it could have been required to settle those derivatives at their termination value of $215.

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 as of March 31, 2010 and December 31, 2009 by the type of securities collateralizing the repurchase agreement:

	March 31, 2010
Collateral Type	Balance		Weighted Average Rate			Fair Value of Collateral
Agency MBS	$	490,754		0.26	%	$	539,276
Non-Agency CMBS		80,077		1.52	%		94,665
Non-Agency RMBS		3,183		1.75	%		3,279
Securitization financing bonds (see Note 9)		28,437		1.64	%		33,394
	$	602,451		0.50	%	$	670,614

	December 31, 2009
Collateral Type	Balance		Weighted Average Rate			Fair Value of Collateral
Agency MBS	$	540,586		0.60	%	$	575,386
Non-Agency securities		73,338		1.73	%		82,770
Securitization financing bonds (see Note 9)		24,405		1.59	%		34,431
	$	638,329		0.76	%	$	692,587

As of March 31, 2010 and December 31, 2009, the repurchase agreements had the following original maturities:

Original Maturity	March 31, 2010		December 31, 2009
30 days or less	$	106,650	$	69,576
31 to 60 days		296,953		300,413
61 to 90 days		70,632		180,643
Greater than 90 days		128,216		87,697
	$	602,451	$	638,329

The following table presents our borrowings by repurchase agreement counterparty as of March 31, 2010:

Counterparty	Repurchase agreements		Fair Value of Collateral		Equity at Risk		Weighted Average Original Maturity
Bank of America Securities, LLC	$	169,279	$	192,469	$	23,190	64 days
All other		433,172		478,145		44,973	51 days
	$	602,451	$	670,614	$	68,163	55 days

NOTE 9 – NON-RECOURSE COLLATERIZED FINANCING

Non-recourse collateralized financing on the Company’s consolidated balance sheet as of March 31, 2010 is comprised of $50,670 of financing provided by the Federal Reserve Bank of New York (the “New York Federal Reserve”) under its Term Asset-Backed Securities Loan Facility (“TALF”) and $150,836 of securitization financing. Non-recourse collateralized financing as of December 31, 2009 was comprised solely of securitization financing with a balance of $143,081. Unlike repurchase agreements, TALF financing and securitization financing are similar in that they are both non-recourse to the Company. The TALF program was discontinued by the New York Federal Reserve in the second quarter of 2010.

During the three months ended March 31, 2010, the Company financed purchases of ‘AAA’-rated CMBS with a par value of $60,800 using TALF financing. As of March 31, 2010, the fair value of these CMBS is $61,584, and the balance of the TALF borrowings is $50,770. The Company incurred $100 in administrative fees which are being amortized and recognized as an adjustment to interest expense on the related TALF borrowings.

As of March 31, 2010, the Company has three series of securitization financing bonds outstanding which were issued pursuant to three separate indentures. One of the series has two classes of bonds outstanding, one of which is owned by third parties and the other, which has been retained by the Company. The class owned by third parties has a principal amount of $23,484 as of March 31, 2010 compared to $23,852 as of December 31, 2009 and is collateralized by single-family mortgage loans with unpaid principal balances of $24,194 as of March 31, 2010 compared to $24,563 as of December 31, 2009. As of March 31, 2010, this class shares additional collateralization of $6,555 with the other class within the same series that the Company retained. This is a variable rate bond which pays interest based on one-month LIBOR plus 0.30%.

The second series of bonds is fixed-rate with a principal amount of $115,141 as of March 31, 2010 compared to $121,168 as of December 31, 2009, and is collateralized by commercial mortgage loans, including defeased loans, with unpaid principal balances of $136,012 as of March 31, 2010 compared to $142,039 as of December 31, 2009.

The third series of bonds is also fixed-rate with a principal amount of $15,000 as of March 31, 2010 and is collateralized by CMBS with a fair value of $15,983. This series represents the portion of a securitization bond the Company sold in December 2009 as part of the re-securitization of CMBS the Company completed in December 2009. Subsequently, amendments to ASC Topic 860 became effective which resulted in the Company consolidating the trust that issued the bond pursuant to ASC Topic 810 as of January 1, 2010. This securitization transaction and amendments to ASC Topics 810 and 860 are discussed further in Note 1.

The components of securitization financing along with certain other information as of March 31, 2010 and December 31, 2009 are summarized as follows:

	March 31, 2010						December 31, 2009
	Bonds Outstanding			Range of Interest Rates			Bonds Outstanding			Range of Interest Rates
Fixed rate classes	$	130,141			6.2 – 7.2	%	$	121,168			6.7% - 7.2	%
Variable rate class		23,484			0.5	%		23,852			0.5	%
Unamortized net bond premium and deferred costs		(2,789	)					(1,939	)
	$	150,836					$	143,081

Weighted average coupon		5.9	%					5.9	%
Range of stated maturities		2016 – 2027						2024 – 2027
Estimated weighted average life	3.4 years						3.0 years

The additional $15,000 of bonds which the Company now consolidates as a result of the amendments to ASC Topic 860 has a weighted average life of 5.6 years which increased the overall estimated weighted average life for securitization financing from 3.0 years as of December 31, 2009 to 3.4 years as of March 31, 2010.

The Company has redeemed securitization bonds in the past, and in certain instances, the Company may decide to keep the bond outstanding, which enables it to more easily finance the redeemed bond. The Company currently has two bonds from different trusts that it had previously redeemed and is currently financing using repurchase agreements. One of these bonds has a par value of $8,243 as of March 31, 2010 and is financed with a repurchase agreement with a balance of $5,873 as of March 31, 2010. This bond is rated ‘AAA’ and is collateralized by commercial mortgage loans with a guaranty of payment by Fannie Mae. The other bond the Company redeemed has a par value of $29,105 as of March 31, 2010 and is also rated ‘AAA’ The second bond is collateralized by single-family mortgage loans and is pledged as collateral to support repurchase agreement borrowings of $22,564 as of March 31, 2010. These bonds are legally outstanding but are eliminated because the issuing trust is already included in the Company’s consolidated financial statements.

NOTE 10 – FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company utilizes fair value measurements at various levels within the hierarchy established by ASC Topic 820 for certain of its assets and liabilities. The three levels of valuation hierarchy established by ASC Topic 820 are as follows:

·	Level 1 – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

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. The Company’s 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, and its derivatives.

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, the Company’s assets and liabilities carried at fair value and included in this category are non-Agency securities and delinquent property tax receivables.

The following table presents the fair value of the Company’s assets and liabilities as of March 31, 2010, segregated by the hierarchy level of the fair value estimate:

			Fair Value Measurements
	Fair Value		Level 1		Level 2		Level 3
Assets:
Agency MBS	$	558,935	$	–	$	558,935	$	–
Non-Agency securities
RMBS		5,131		–		–		5,131
CMBS		183,606		–		61,583		122,023
Other		132		–		–		132
Total assets carried at fair value	$	747,804	$	–	$	620,518	$	127,286

Liabilities:
Derivative liabilities		187		–		187		–
Total liabilities carried at fair value	$	187	$	–	$	187	$	–

Non-Agency RMBS and certain CMBS are comprised of securities for which there are not substantially similar securities that trade frequently. As such, the Company determines the fair value those securities by discounting the estimated future cash flows derived from pricing models using assumptions that are confirmed to the extent possible by third party dealers or other pricing indicators. Significant inputs into the pricing models are Level 3 in nature due to the lack of readily available market quotes and utilize information such as the security’s coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected losses, and credit enhancement, as well as certain other relevant information. The following tables present the beginning and ending balances of the Level 3 fair value estimates for the three months ended March 31, 2010 and March 31, 2009:

	Level 3 Fair Values
	Non-Agency CMBS			Non-Agency RMBS			Other		Total assets
Balance as of December 31, 2009	$	103,203		$	5,907		$	131	$	109,241
Cumulative effect of adoption of new accounting principle		14,924			–			–		14,924
Balance as of January 1, 2010		118,127			5,907			131		124,165
Total realized and unrealized gains (losses):
Included in the statement of operations		–			–			–		–
Included in other comprehensive income		6,890			(16	)		–		6,874
Purchases, sales, issuances and other settlements, net		(2,994	)		(760	)		1		(3,753	)
Transfers in and/or out of Level 3		–			–			–		–
Balance as of March 31, 2010	$	122,023		$	5,131		$	132	$	127,286

	Level 3 Fair Values
	Non-Agency CMBS		Non-Agency RMBS			Other			Total assets			Obligation under payment agreement
Balance as of December 31, 2008	$	–	$	6,259		$	211		$	6,470		$	(8,534	)
Total realized and unrealized gains (losses):
Included in the statement of operations		–		–			1			1			563
Included in other comprehensive income		–		(760	)		6			(754	)		–
Purchases, sales, issuances and other settlements, net		–		571			(50	)		521			–
Transfers in and/or out of Level 3		–		–			–			–			–
Balance as of March 31, 2009	$	–	$	6,070		$	168		$	6,238		$	(7,971	)

The following table presents the recorded basis and estimated fair values of the Company’s financial instruments as of March 31, 2010 and December 31, 2009:

	March 31, 2010				December 31, 2009
	Recorded Basis		Fair Value		Recorded Basis		Fair Value
Assets:
Agency MBS	$	558,935	$	558,935	$	594,120	$	594,120
Non-Agency CMBS		183,606		183,606		103,203		103,203
Non-Agency RMBS		5,131		5,131		5,907		5,907
Securitized mortgage loans, net		204,609		181,289		212,471		186,547
Other investments		2,156		2,263		2,280		2,079
Derivative assets		–		–		1,008		1,008

Liabilities:
Repurchase agreements		602,451		602,451		638,329		638,329
Non-recourse collateralized financing		201,506		194,326		143,081		132,234
Derivative liabilities		187		187		–		–

There were no assets or liabilities which were measured at fair value on a non-recurring basis as of March 31, 2010 or December 31, 2009.

The following table presents certain information for Agency MBS and non-Agency securities that were in an unrealized loss position as of March 31, 2010 and December 31, 2009:

	March 31, 2010				December 31, 2009
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Unrealized loss position for:
Less than one year:
Agency MBS	$	73,282	$	215	$	73,288	$	302
Non-Agency CMBS		65,672		216		92,438		4,145
One year or more:
Non-Agency RMBS		3,689		885		4,087		971
	$	142,643	$	1,316	$	169,813	$	5,418

The Company reviews the estimated future cash flows for its non-Agency securities to determine whether there have been adverse changes in the cash flows that necessitate recognition of other-than-temporary impairment amounts. Approximately $65,190 of the non-Agency securities in an unrealized loss position as of March 31, 2010 are investment grade MBS collateralized by mortgage loans that were originated during or prior to 1999. Based on the credit rating of these MBS and the seasoning of the mortgage loans collateralizing these securities, the impairment of these MBS is not determined to be other-than-temporary as of March 31, 2010.

The estimated cash flows of the remaining $4,171 of non-Agency securities 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, management did not determine any adverse changes in the timing or amount of estimated cash flows that necessitate recognition of other-than-temporary impairment amounts as of March 31, 2010.

NOTE 11 – PREFERRED AND COMMON STOCK

The Company initiated a controlled equity offering program (“CEOP”) on March 16, 2009 by filing a prospectus supplement under its shelf registration statement filed in 2008. The CEOP allows the Company to offer and sell through Cantor Fitzgerald & Co., as its 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 1933 Act, including sales made directly on the New York Stock Exchange or sales made to or through a market maker other than on an exchange. For the three months ended March 31, 2010, the Company sold 1,070,100 shares of its common stock through the CEOP at an average price of $9.03 per share, for which it received proceeds of $9,453, net of broker sales commissions. As of March 31, 2010, there are 180,650 shares of the Company’s common stock available for offer and sale under the CEOP.

The Company also issued shares under its 2009 Stock and Incentive Plan for a portion of management’s 2009 performance bonus as well as for its Chief Executive Officer’s 2010 salary through March 31, 2010.

The following table presents a summary of the changes in the number of preferred and common shares outstanding for the three months ended March 31, 2010:

	Preferred Stock Series D		Common Stock
January 1, 2010		4,221,539		13,931,512
Common stock issued under CEOP		-		1,070,100
Common stock issued under 2009 Stock and Incentive Plan		-		36,190
March 31, 2010		4,221,539		15,037,802

On March 17, 2010, the Company declared preferred and common dividends of $0.2375 and $0.23, respectively, to be paid on April 30, 2010 to shareholders of record on March 31, 2010.

NOTE 12 – EMPLOYEE BENEFITS

Stock Incentive Plan

Pursuant to the Company’s 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. Of the 2,500,000 shares of common stock authorized for issuance under this plan, 2,453,810 shares remain available as of March 31, 2010. Although the Company is no longer issuing stock based compensation under its 2004 Stock Incentive Plan, there are stock options, SARs, and restricted stock still outstanding (and exercisable if vested) as of March 31, 2010.

As required by ASC Topic 718, stock options which may be settled only in shares of common stock have been treated as equity awards with their fair value measured at the grant date, and SARs that may be settled only in cash have been treated as liability awards with their fair value measured at the grant date and remeasured at the end of each reporting period. The fair value of SARs was estimated as of March 31, 2010 and December 31, 2009 using the Black-Scholes option valuation model based upon the assumptions in the table below.

	March 31, 2010	December 31, 2009
Expected volatility	19.9%-28.1%	25.4%-30.9%
Weighted-average volatility	24.3%	29.4%
Expected dividends	10.1%	10.4%
Expected term (in months)	16	18
Weighted-average risk-free rate	1.61%	1.87%
Range of risk-free rates	1.07%-2.32%	1.44%-2.42%

The following table presents a rollforward of the SARs activity for the following periods:

Three Months Ended March 31,

2010

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

–

SARs exercised

–

SARs outstanding at end of period

278,146

7.27

278,146

7.27

The weighted average remaining contractual term on the SARs outstanding as of March 31, 2010 is 31 months. There are 258,146 SARs vested and exercisable at a weighted average price of $7.29 as of March 31, 2010, of which 38,750 vested during the three months ended March 31, 2010. As of March 31, 2009, 219,396 of the SARS outstanding at that time were vested and exercisable at a weighted average price of $7.37, of which 69,536 vested during the three months ended March 31, 2009.

The following table presents a rollforward of the stock option activity for the following periods:

Three Months Ended March 31,

2010

2009

Number of Shares

Weighted-Average Exercise Price

Number of Shares

Weighted-

Average

Exercise

Price

Options outstanding at beginning of period

95,000

8.59

110,000

8.55

Options granted

–

Options forfeited

–

Options exercised

–

Options outstanding at end of period (all vested and exercisable)

95,000

8.59

110,000

8.55

The following table presents a rollforward of the restricted stock activity for the following periods:

	Three Months Ended March 31,
	2010			2009
Restricted stock at beginning of period		32,500			30,000
Restricted stock granted		–			–
Restricted stock forfeited		–			–
Restricted stock vested		(7,500	)		(7,500	)
Restricted stock outstanding at end of period		25,000			22,500

The Company recognized stock based compensation expense of $59 and $67 for the three months ended March 31, 2010 and March 31, 2009, respectively. The total remaining compensation cost related to non-vested awards was $31 as of March 31, 2010 and will be recognized as the awards vest.

Employee Savings Plan

The Company provides an Employee Savings Plan under Section 401(k) of the Code. The Employee Savings Plan allows eligible employees to defer up to 25% of their income on a pretax basis. The Company matches the employees’ contribution, up to 6% of the employees’ eligible compensation. The Company may also make discretionary contributions based on the profitability of the Company. The total expense related to the Company’s matching and discretionary contributions for the three months ended March 31, 2010 and March 31, 2009 was $59 and $39, respectively. The Company does not provide post-employment or post-retirement benefits to its employees.

NOTE 13 – COMMITMENTS AND CONTINGENCIES

The Company and its subsidiaries may be involved in certain litigation matters arising in the ordinary course of business. 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 arising in the ordinary course of business will not have a material adverse effect on the Company’s consolidated balance sheet, but could have affect its consolidated results of operations in a given period. Information on litigation arising out of the ordinary course of business is described below.

One of the Company’s subsidiaries, GLS Capital, Inc. (“GLS”), and the County of Allegheny, Pennsylvania are defendants in a class action lawsuit (“Pentlong”) filed in 1997 in the Court of Common Pleas of Allegheny County, Pennsylvania (the "Court of Common Pleas"). Between 1995 and 1997, GLS purchased delinquent county property tax

receivables for properties located in Allegheny County. In its initial pleadings, the Pentlong plaintiffs alleged that GLS did not have the right to recover from delinquent taxpayers certain attorney fees, lien docketing, revival, assignment and satisfaction costs, and expenses associated with the original purchase transaction, and interest, in the collection of the property tax receivables. During the course of the litigation, the Pennsylvania State Legislature enacted Act 20 of 2003, which cured many deficiencies in the Pennsylvania Municipal Claims and Tax Lien Act at issue in the Pentlong case, including confirming GLS’ right to collect attorney fees from delinquent taxpayers retroactive back to the date when GLS first purchased the delinquent tax receivables.

In August 2009, based on the provisions of Act 20, GLS filed a Motion for Summary Judgment and supporting Brief in the Court of Common Pleas seeking dismissal of the Plaintiffs’ remaining claims regarding GLS’ right to collect reasonable attorneys fees from the named plaintiffs and purported class members; namely, its right to collect lien docketing, revival, assignment and satisfaction costs from delinquent taxpayers; and its practice of charging interest on the first of each month for the entire month. Subsequently the plaintiffs abandoned their claims with respect to lien docketing and satisfaction costs and the issue of interest. On April 2, 2010, the Court of Common Pleas granted GLS’ motion for summary judgment with respect to its right to charge attorney fees and interest in the collection of the receivables, removing these claims from plaintiffs’ case. While the Court indicated at that time that it lacked sufficient information to rule on the remaining aspects of the motion related to the reasonableness of attorney fees and lien costs, during a status conference between the parties and the judge on April 13, 2010, the judge invited GLS to renew its motion for summary judgment on the issue of GLS’ right to recover lien assignment and revival costs from delinquent taxpayers.

With relation to the claim regarding the reasonableness of attorney fees recovered by GLS, no motion is currently pending. However, GLS plans to seek decertification of the class once the lien cost issue is decided by the court because GLS believes the class action vehicle will no longer be appropriate if the only issue before the court is a challenge to the reasonableness of attorneys fees charged in each individual case.

Plaintiffs have not enumerated their damages in this matter.

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 Supreme Court of Texas related to the matter of Basic Capital Management, Inc. et al. (collectively, “BCM” or the “Plaintiffs”) versus DCI et al. The appeal seeks to overturn the trial court’s judgment, and subsequent affirmation by the Fifth Court of Appeals at Dallas, in our and DCI’s favor which denied recovery to Plaintiffs. Specifically, Plaintiffs are seeking reversal of the trial court’s judgment and sought rendition of judgment against us for alleged breach of loan agreements for tenant improvements in the amount of $253,000. They also seek reversal of the trial court’s judgment and rendition of judgment against DCI in favor of BCM under two mutually exclusive damage models, for $2,200 and $25,600, respectively, related to the alleged breach by DCI of a $160,000 “master” loan commitment. Plaintiffs also seek reversal and rendition of a judgment in their favor for attorneys’ fees in the amount of $2,100. Alternatively, Plaintiffs seek a new trial. Even if Plaintiffs were to be successful on appeal, DCI is a former affiliate of the Company, and therefore management does not believe that it would be obligated for any amounts awarded to the Plaintiffs as a result of the actions of DCI. There have been no further material developments in this case through March 31, 2010.

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 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”). The complaint was filed on February 7, 2005, and purports to be a class action on behalf of purchasers between February 2000 and May 2004 of MERIT Series 12 and MERIT Series 13 securitization financing bonds (“Bonds”), which are collateralized by manufactured housing loans. After a series of rulings by the District Court and an appeal by us and MERIT, on February 22, 2008 the United States Court of Appeals for the Second Circuit dismissed the litigation against us and MERIT. Teamsters filed an amended complaint on August 6, 2008 with the District Court which essentially restated the same allegations as the original complaint and added our former president and our current Chief Operating Officer as defendants. Teamsters seeks unspecified damages and alleges, among other things, fraud and misrepresentations in connection with the issuance of and subsequent reporting related to the Bonds. On October 19, 2009, the District Court substantially denied the

Defendants’ motion to dismiss the Teamsters’ second amended complaint. On December 11, 2009, the Defendants filed an answer to 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. There have been no further material developments in this case through March 31, 2010.

NOTE 14 – ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income as of March 31, 2010 and December 31, 2009 is comprised of the following items:

	March 31, 2010			December 31, 2009
Available for sale investments:
Unrealized gains	$	15,606		$	14,472
Unrealized losses		(1,317	)		(5,419	)
		14,289			9,053
Hedging instruments:
Unrealized gains		–			1,008
Unrealized losses		(177	)		–
		(177	)		1,008

Accumulated other comprehensive income	$	14,112		$	10,061

Due to the Company’s REIT status, the items comprising other comprehensive income do not have related tax effects.

NOTE 15 – SUBSEQUENT EVENTS

Management has evaluated events and circumstances occurring as of and through the date this Quarterly Report on Form 10-Q was filed with the SEC and made available to the public, and has determined that there have been no significant events or circumstances that provide additional evidence about conditions of the Company that existed as of March 31, 2010, or that qualify as “recognized subsequent events” as defined by ASC Topic 855.

Management has determined that the following events, which occurred subsequent to March 31, 2010 and before the filing of this Quarterly Report on Form 10-Q, qualify as “nonrecognized subsequent events” as defined by ASC Topic 855:

The Company has issued an additional 70,940 common shares since March 31, 2010 through its CEOP and 2009 Stock and Incentive Plan. In addition, 10,000 stock options issued under its 2004 Stock Incentive Plan were exercised subsequent to March 31, 2010.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to increase understanding of, and should be read in conjunction with, our unaudited consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q and our audited Annual Report on Form 10-K for the year ended December 31, 2009. In addition to current and historical information, the following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future business, financial condition or results of operations. For a description of certain factors that may have a significant impact on our future business, financial condition or results of operations, see “Forward-Looking Statements” at the end of this discussion and analysis.

EXECUTIVE OVERVIEW

We are a real estate investment trust, or REIT, which invests in mortgage-backed securities (“MBS”) and loans on a leveraged basis. As of March 31, 2010, we have total investments of approximately $954.4 million.

Our objective as a Company is to provide attractive risk-adjusted returns to our shareholders over the long term through dividends paid and through capital appreciation. Our strategy consists of investments in MBS, including Agency and non-Agency securities, and in securitized mortgage loans. As of March 31, 2010, our investment portfolio consisted of $558.9 million in Agency MBS, $188.7 million in non-Agency MBS, and $204.6 million in securitized mortgage loans. Our Agency and non-Agency MBS are recorded on our consolidated balance sheets at their fair value, and our securitized mortgage loans are recorded on our consolidated balance sheets at amortized cost.

Agency MBS are securities issued or guaranteed by a federally chartered corporation, such as Federal National Mortgage Corporation (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. government, such as Government National Mortgage Association (“Ginnie Mae”). The majority of our Agency MBS are collateralized by residential mortgage loans, which generally have a variable interest rate, while a minor portion of our Agency MBS are collateralized by commercial mortgage loans, which generally have a fixed interest rate.

With respect to our investment in Agency MBS, we principally invest in Hybrid Agency ARMs, Agency ARMs, and fixed-rate Agency MBS. Hybrid Agency ARMs are RMBS collateralized by hybrid adjustable-rate mortgage loans, which have a fixed-rate of interest for a specified period (typically three to ten years) and which then reset their interest rates at least annually to an increment over a specified interest rate index. Hybrid Agency ARMs that are within twelve months of the end of their fixed-rate periods are classified within Agency ARMs. Agency ARMs are RMBS collateralized by adjustable rate mortgage loans that have interest rates that generally will adjust at least annually to an increment over a specified interest rate index. In an attempt to minimize our exposure to increases in interest rates, we have focused on shorter-duration ARMs. As of March 31, 2010, our Agency MBS were collateralized by approximately $253.9 million in Hybrid Agency ARMs, $302.1 million in Agency ARMs, and $2.9 million in fixed rate Agency MBS.

With respect to our investment in non-Agency securities, we principally invest in higher quality, fixed-rate securities. As of March 31, 2010, $183.6 million of our non-Agency securities are CMBS, of which $179.5 million is ‘AAA’-rated or guaranteed by Fannie Mae or Freddie Mac.

We employ leverage in order to increase the overall yield on our invested capital. Our primary source of income is net interest income, which is the excess of the interest income earned on our investments over the cost of financing these investments. Although our intention is generally to hold our investments on a long-term basis, we may occasionally sell investments prior to their maturity.

We finance our investments through a combination of short-term repurchase agreements, securitization financing, and equity capital. In the first quarter of 2010 we financed $60.8 million in CMBS with $50.8 million in financing provided by the Federal Reserve Bank of New York pursuant to its Term Asset-Backed Securities Loan Facility (“TALF”) program. Similar to securitization financing, TALF financing is also non-recourse to the Company. The TALF program will be discontinued by the New York Federal Reserve in the second quarter of 2010, and we do not anticipate financing any additional investments through the TALF.

As a REIT, we are required to distribute to our shareholders as dividends on our preferred and common stock at least 90% of our taxable income, which is our income as calculated for income tax purposes after consideration of our tax net operating loss carryforwards (“NOLs”), which had a balance of approximately $156.7 million as of December 31, 2008. We anticipate utilizing approximately $7.5 million of the NOL carryforward to offset our 2009 taxable income, but this amount is subject to change as we complete our 2009 tax return. Provided that we do not experience an ownership shift as defined under Section 382 of the Internal Revenue Code (“Code”), we may utilize the NOLs to offset portions of our distribution requirements for our REIT taxable income with certain limitations. If we do incur an ownership shift under Section 382 of the Code, then the use of the NOLs to offset REIT distribution requirements may be limited.

Market Conditions

The volatility experienced in the credit markets over the last several years resulted in extraordinary and often coordinated measures by global central banks and governments to increase the liquidity in and provide stability to the credit markets. Some of these activities included participation by central banks and governments in markets in which they would not normally participate. For example, among other programs, the U.S. Treasury Department (“Treasury”) and the Federal Reserve initiated programs to purchase Agency MBS, principally fixed-rate Agency RMBS, in the open market pursuant to a congressional grant of authority. In addition, the New York Federal Reserve initiated financing programs, for certain types of securities such as the TALF, in order to provide liquidity to the credit markets. The Federal Reserve also lowered the targeted Federal Funds rate seven times in 2008 from 4.25% to its current 0.25%. Active participation by governmental entities in the markets appears to have been effective, resulting in generally more liquid and less volatile markets. A side effect of this participation has been an increase in related asset prices with a corresponding decrease in their yields.

Over the last year, credit markets have begun to function more normally, and the Treasury and the Federal Reserve have begun to withdraw from participation in private markets. During the first quarter of 2010, the Federal Reserve discontinued purchasing Agency RMBS and discontinued the TALF program for certain investments. In addition, the Federal Reserve and Treasury have been openly discussing options for withdrawing liquidity from the credit markets, including selling Agency RMBS, engaging in reverse repurchase agreement transactions, and raising the Federal Funds target rate. The ultimate impact on the markets of the withdrawal of governmental support and/or higher interest rates is uncertain. Market reactions to such withdrawal could be severe, or alternatively, the withdrawal of government support could result in investment opportunities as asset prices decline and yields increase.

In addition, as economic activity improves, the Federal Reserve may also decide to increase the targeted Federal Funds rate. Such an increase will have an impact on our funding costs because our repurchase agreement financing is based on LIBOR, which typically closely tracks the Federal Funds rate.

In the first quarter of 2010, both Fannie Mae and Freddie Mac announced delinquent loan buyout operations pursuant to which 120+ day delinquent loans would be purchased out of existing MBS pools. Freddie Mac completed its buy-outs in March 2010, and Fannie Mae will begin its buy-out activity in April and is expected to conclude its buy-outs in July 2010. Delinquent loan buy-outs by Fannie Mae and Freddie Mac result in prepayments of our Agency MBS, which increase premium amortization and reduce the interest income we earn on these securities.

At March 31, 2010, Fannie Mae MBS represented 68.6% of the fair value of our Agency MBS portfolio. Our first quarter results reflect the actual impact of the Freddie Mac delinquent loan buy-outs and the anticipated impact of the Fannie Mae buy-outs. To the extent the Fannie Mae buy-outs exceed our expectations in the second quarter, our premium amortization would increase during that quarter, which would reduce our net interest income, and our interest-earning assets would decrease. In addition, because returns available on Agency MBS today are generally lower than the returns in our current Agency MBS investment portfolio, reinvestment of amounts received from pay-downs on our existing portfolio may be at lower yields than the yield on our current portfolio, which could negatively impact our net interest income. Based on the composition of our Agency MBS portfolio and information published by Fannie Mae regarding its delinquent loan buy-outs, we currently expect prepayments on our Fannie Mae Agency MBS to approximate $60 million for the second quarter. These are only estimates and will be greatly impacted by Fannie Mae’s actual buy-out activity. We do not anticipate a meaningful change in our net interest income for the second quarter of 2010 if Fannie Mae’s second quarter prepayments are in-line with our estimate.

During the first quarter we continued to benefit from the exceptionally low Federal Funds rate and steep yield curve. Our net interest spread for the quarter was 2.96% versus 2.78% for the same period last year. Funding for Agency MBS and non-Agency securities has continued to improve since year end. We added $79.6 million (net) in non-Agency securities (including changes in the net unrealized gains on those securities), which were financed primarily with TALF financing as discussed above. Our Agency MBS shrank $35.2 million (net) over the quarter as we experienced higher prepayments from delinquent loan buy-outs by Freddie Mac during the quarter, and we reinvested available proceeds in non-Agency securities, principally CMBS.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of operations are based in large part upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. We base these estimates and judgments on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual results, however, may differ from the estimated amounts we have recorded.

Our accounting policies require significant management estimates, judgments or assumptions and are considered critical to our results of operations or financial position relate to consolidation of subsidiaries, securitization, fair value measurements, impairments, allowance for loan losses and amortization of premiums/discounts on Agency MBS. Our critical accounting policies are discussed in our Annual Report on Form 10-K for the year ended December 31, 2009 under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and in Note 1 to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. There have been no changes in our critical accounting policies as discussed in our Annual Report on Form 10-K for the year ended December 31, 2009, except as discussed in Note 1 to Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

FINANCIAL CONDITION

The following discussion addresses our balance sheet items that had significant activity during the past quarter and should be read in conjunction with the Condensed Notes to Unaudited Consolidated Financial Statements contained within Item 1 of Part I to this Quarterly Report on Form 10-Q.

Agency MBS

Our Agency MBS investments, which are classified as available-for-sale and carried at fair value, are comprised as follows:

(amounts in thousands)	March 31, 2010		December 31, 2009
Agency MBS:
Hybrid ARMs	$	236,963	$	293,428
ARMs		298,886		297,002
		535,849		590,430
Fixed-rate		2,959		131
		538,808		590,561
Principal receivable		20,127		3,559
	$	558,935	$	594,120

During the first quarter of 2010, we purchased approximately $7.4 million of Agency MBS. The weighted average price on our Agency MBS decreased to 104.0 as of March 31, 2010 from 104.2 as of December 31, 2009. We received $56.3 million of principal on the securities during the three-month period ended March 31, 2010.

As of March 31, 2010, our portfolio of Agency MBS included net unamortized premiums of $12.0 million, or 2.3% of the par value of the securities, compared to net unamortized premiums of $12.9 million, or 2.3% of the par value of the securities, as of December 31, 2009.

The average quarterly constant prepayment rate (“CPR”) realized on our Agency MBS portfolio was 28.6% for the first quarter of 2010 compared to 14.8% for the comparable period of 2009. The increase in CPR is primarily related to the buyout of mortgage loans delinquent by more than 120 days by Freddie Mac during the first quarter of 2010, which are discussed further in “Liquidity and Capital Resources”.

Securitized Mortgage Loans, Net

Securitized mortgage loans are comprised of loans secured by first deeds of trust on single-family residential and commercial properties. Our net basis in these loans at amortized cost, which includes discounts, premiums, deferred costs, and allowance for loan losses, is presented in the following table by the type of property collateralizing the loan.

(amounts in thousands)	March 31, 2010		December 31, 2009
Securitized mortgage loans, net:
Commercial	$	144,029	$	150,371
Single-family		60,580		62,100
	$	204,609	$	212,471

Our securitized commercial mortgage loans are pledged to two securitization trusts, which were issued in 1993 and 1997, and have outstanding principal balances, including defeased loans, of $12.9 million and $136.0 million, respectively, as of March 31, 2010 compared to $13.1 million and $142.0 million, respectively, as of December 31, 2009. The decrease in the balance of these mortgage loans from December 31, 2009 to March 31, 2010 was primarily related to principal payments, net of amounts received on defeased loans, of $6.5 million. We provided approximately $0.2 million for estimated losses on these commercial mortgage loans as a result of an increase in estimated losses on the commercial loan portfolio.

Our securitized single-family mortgage loans are pledged to a securitization trust established in 2002 using loans that were principally originated between 1992 and 1997. The decrease in the balance of these mortgage loans