Edgar Filing: DYNEX CAPITAL INC

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 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 November 3, 2010, the registrant had 23,241,826 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 September 30, 2010 (unaudited) and December 31, 2009	1

		Consolidated Statements of Income for the three and nine months ended September 30, 2010 and September 30, 2009 (unaudited)	2

		Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2010 and September 30, 2009 (unaudited)	3

		Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2010 (unaudited)	4

		Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and September 30, 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	29

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	54

	Item 4.	Controls and Procedures	61

PART II.	OTHER INFORMATION

	Item 1.	Legal Proceedings	62

	Item 1A.	Risk Factors	63

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63

	Item 3.	Defaults Upon Senior Securities	63

	Item 4.	(Removed and Reserved)	63

	Item 5.	Other Information	63

	Item 6.	Exhibits	64

SIGNATURES			65

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

DYNEX CAPITAL, INC.

CONSOLIDATED BALANCE SHEETS

(amounts in thousands except share data)

	September 30, 2010			December 31, 2009
	(unaudited)
ASSETS
Agency MBS (including pledged of $601,559 and $575,386, respectively)	$	676,843		$	594,120
Non-Agency MBS (including pledged of $197,093 and $82,770, respectively)		225,371			109,110
Securitized mortgage loans, net		160,895			212,471
Other investments, net		1,437			2,280
		1,064,546			917,981

Cash and cash equivalents		17,194			30,173
Derivative assets		–			1,008
Accrued interest receivable		4,132			4,583
Other assets, net		5,963			4,317
Total assets	$	1,091,835		$	958,062

LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities:
Repurchase agreements	$	745,147		$	638,329
Non-recourse collateralized financing		108,027			143,081
Derivative liabilities		4,889			–
Accrued interest payable		790			1,208
Other liabilities		7,508			6,691
		866,361			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, 4,221,387 shares
issued and outstanding ($43,269 aggregate liquidation preference)		41,748			41,749
Common stock, par value $.01 per share, 100,000,000 shares authorized; 18,709,394 and 13,931,512 shares issued and outstanding, respectively		187			139
Additional paid-in capital		423,700			379,717
Accumulated other comprehensive income		17,600			10,061
Accumulated deficit		(257,761	)		(262,913	)
		225,474			168,753
Total liabilities and shareholders’ equity	$	1,091,835		$	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						Nine Months Ended
	September 30,						September 30,
	2010			2009			2010			2009
Interest income:
Agency MBS	$	5,607		$	5,413		$	15,085		$	14,943
Non-Agency MBS		3,345			154			9,586			470
Securitized mortgage loans		2,748			3,832			9,726			13,138
Other investments		30			49			94			184
Cash and cash equivalents		4			4			9			13
		11,734			9,452			34,500			28,748
Interest expense:
Repurchase agreements		(1,672	)		(668	)		(4,297	)		(2,561	)
Non-recourse collateralized financing		(1,661	)		(1,769	)		(6,674	)		(7,455	)
Other interest expense		–			(418	)		–			(1,210	)
		(3,333	)		(2,855	)		(10,971	)		(11,226	)

Net interest income		8,401			6,597			23,529			17,522
Provision for loan losses		(211	)		(248	)		(770	)		(566	)
Net interest income after provision for loan losses		8,190			6,349			22,759			16,956

Gain on sale of investments, net		–			–			794			220
Fair value adjustments, net		77			(457	)		230			(319	)
Other income, net		726			29			1,950			193
Equity in income of joint venture, net		–			1,620			–			1,476
General and administrative expenses:
Compensation and benefits		(1,191	)		(824	)		(3,033	)		(2,776	)
Other general and administrative expenses		(780	)		(715	)		(2,874	)		(2,245	)

Net income		7,022			6,002			19,826			13,505
Preferred stock dividends		(1,056	)		(1,003	)		(3,061	)		(3,008	)

Net income to common shareholders	$	5,966		$	4,999		$	16,765		$	10,497

Weighted average common shares:
Basic		17,230			13,552			15,532			12,908
Diluted		21,457			17,776			19,757			17,131
Net income per common share:
Basic	$	0.35		$	0.37		$	1.08		$	0.81
Diluted	$	0.33		$	0.34		$	1.00		$	0.79

Dividends declared per common share	$	0.25		$	0.23		$	0.94		$	0.69

See condensed notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(amounts in thousands)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2010			2009			2010			2009
Net income	$	7,022		$	6,002		$	19,826		$	13,505
Other comprehensive income:
Available-for-sale securities:
Change in market value		2,212			4,030			14,199			11,461
Reclassification adjustment for net gain on sale of investments		–			1			(779	)		(220	)
Reclassification adjustment for equity in the joint venture’s other-than-temporary impairment		–			–			–			707
Net unrealized loss on cash flow hedging instruments		(2,048	)		–			(5,881	)		–
Other comprehensive income		164			4,031			7,539			11,948

Comprehensive income		7,186			10,033			27,365			25,453
Dividends declared on preferred stock		(1,056	)		(1,003	)		(3,061	)		(3,008	)
Comprehensive income to common shareholders	$	6,130		$	9,030		$	24,304		$	22,445

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		–			47		43,963		–		–			44,010
Restricted stock vesting		–			–		20		–		–			20
Conversion of preferred shares to common shares		(1	)		1		–		–		–			–
Cumulative effect of adoption ofnew accounting principle		–			–		–		–		12			12
Net income		–			–		–		–		19,826			19,826
Dividends on preferred stock		–			–		–		–		(3,061	)		(3,061	)
Dividends on common stock		–			–		–		–		(11,625	)		(11,625	)
Other comprehensive income		–			–		–		7,539		–			7,539
Balance as of September 30, 2010	$	41,748		$	187	$	423,700	$	17,600	$	(257,761	)	$	225,474

See condensed notes to unaudited consolidated financial statements.

DYNEX CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(amounts in thousands)

	Nine Months Ended September 30,
	2010			2009
Operating activities:
Net income	$	19,826		$	13,505
Adjustments to reconcile net income to cash provided by operating activities:
Decrease (increase) in accrued interest receivable		451			(1,016	)
Decrease in accrued interest payable		(418	)		(600	)
Provision for loan losses		769			566
Gain on sale of investments, net		(794	)		(220	)
Gain on redemption of securitization financing bonds		(561	)		–
Fair value adjustments, net		(230	)		319
Equity in income of joint venture, net		–			(1,476	)
Amortization and depreciation		4,266			1,812
Stock based compensation expense		558			426
Net change in other assets and other liabilities		(3,301	)		(980	)
Net cash and cash equivalents provided by operating activities		20,566			12,336

Investing activities:
Purchase of investments		(432,182	)		(364,575	)
Principal payments received on investments		207,485			86,448
Change in principal payment receivable on investments		168			(1,833	)
Proceeds from sales of investments		50,882			3,699
Principal payments received on securitized mortgage loans		51,109			17,130
Other investing activities		(295	)		190
Net cash and cash equivalents used in investing activities		(122,833	)		(258,941	)

Financing activities:
Borrowings under repurchase agreements, net		106,818			271,544
Borrowings under non-recourse collateralized financing		50,678			–
Principal payments on non-recourse collateralized financing		(42,652	)		(13,256	)
Redemption of securitization financing		(56,406	)		(15,493	)
Decrease in restricted cash		–			2,974
Proceeds from issuance of common stock		44,010			9,884
Dividends paid		(13,160	)		(11,634	)
Net cash and cash equivalents provided by financing activities		89,288			244,019

Net decrease in cash and cash equivalents		(12,979	)		(2,586	)
Cash and cash equivalents at beginning of period		30,173			24,335
Cash and cash equivalents at end of period	$	17,194		$	21,749

Supplemental Non-Cash Investing and Financing Activities:
Common dividends declared but not paid	$	4,677		$	3,121
Preferred dividends declared but not paid	$	1,055		$	1,003

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 and nine months ended September 30, 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 changes in accrued interest receivable and accrued interest payable, which were previously included within net change in other assets and other liabilities as well as within other investing activities. These respective amounts on the consolidated statement of cash flows for the nine months ended September 30, 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 MBS, 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 Agency MBS 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 MBS. The Company’s non-Agency MBS are comprised of CMBS and RMBS, the majority of which are investment grade rated. Interest rates for non-Agency MBS collateralized with adjustable rate mortgage loans are based on indexes similar to those of Agency MBS. Like Agency MBS, the Company accounts for its non-Agency MBS in accordance with ASC Topic 320, and all of the Company’s non-Agency MBS 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 MBS based upon prices obtained from a third-party pricing service and broker quotes with the remainder of the non-Agency MBS 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. Like Agency MBS, the Company generally intends to hold its investments in non-Agency MBS until maturity, but it may, from time to time, sell any of its securities as part of the overall management of its business. 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 are evaluated on a pool basis for a general allowance.

The Company considers various factors in determining its specific and general allowance requirements, including 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 legally structured as a sale and repurchase obligation, a repurchase agreement is generally treated 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 balance sheet of the Company as of December 31, 2009, but is included in the consolidated balance sheet as of September 30, 2010 as required by amendments to ASC Topic 860 which became effective January 1, 2010.

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 established 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 September 30, 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 expected life of the investment using the effective interest method. Interest income on non-Agency MBS 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, which states that 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 January 2010, FASB issued Accounting Standards Update (“ASU” or “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. The Company has not had any transfers into or out of levels 1 or 2, but will provide these disclosures in the future when such a change occurs. 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 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. As such, the amendments provided in ASU No. 2009-17 were adopted by the Company effective January 1, 2010.

In April 2010, FASB issued ASU No. 2010-18, which amends ASC Topic 310 to 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. Management has evaluated these amendments and has determined that they will not have a material impact on the Company’s financial condition or results of operations.

In July 2010, FASB issued ASU No. 2010-20, which amends ASC Topic 310 to require additional disclosures regarding an entity’s long-term financing receivables that are measured at amortized cost. Specifically, entities are to provide disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The ASU makes changes to existing disclosure requirements and includes additional disclosure requirements about financing receivables, including credit quality indicators of financing receivables at the end of the reporting period by class; the aging of past due financing receivables at the end of the reporting period by class; and the nature and extent of troubled debt restructurings that occurred during the period by class and their effect on the allowance for credit losses. For public entities, the disclosure requirements of ASC Topic 310 regarding financing receivables as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosure requirements of ASC Topic 310 about troubled debt restructuring activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. Because these amendments to ASC Topic 310 relate only to disclosures and do not alter GAAP, they do not impact the Company’s financial condition or results of operations.

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 September 30,
	2010					2009
	Income			Weighted-Average Common Shares		Income			Weighted- Average Common Shares
Net income	$	7,022				$	6,002
Preferred stock dividends		(1,056	)				(1,003	)
Net income to common shareholders		5,966			17,230,410		4,999			13,551,994
Effect of dilutive items		1,056			4,226,862		1,003			4,224,346
Diluted	$	7,022			21,457,272	$	6,002			17,776,340

Net income per common share:
Basic				$	0.35				$	0.37
Diluted				$	0.33				$	0.34

Components of dilutive items:
Convertible preferred stock	$	1,056			4,221,387	$	1,003			4,221,539
Stock options		–			5,475		–			2,807
	$	1,056			4,226,862	$	1,003			4,224,346

	Nine Months Ended September 30,
	2010					2009
	Income			Weighted-Average Common Shares		Income			Weighted- Average Common Shares
Net income	$	19,826				$	13,505
Preferred stock dividends		(3,061	)				(3,008	)
Net income to common shareholders		16,765			15,531,847		10,497			12,908,243
Effect of dilutive items		3,061			4,225,145		3,008			4,222,306
Diluted	$	19,826			19,756,992	$	13,505			17,130,549

Net income per common share:
Basic				$	1.08				$	0.81
Diluted				$	1.00				$	0.79

Components of dilutive items:
Convertible preferred stock	$	3,061			4,221,387	$	3,008			4,221,539
Stock options		–			3,758		–			767
	$	3,061			4,225,145	$	3,008			4,222,306

Because their inclusion would have been anti-dilutive, the calculation of diluted net income per common share excludes 15,000 unexercised stock option awards for the nine months ended September 30, 2010 and excludes 70,000 unexercised stock option awards for both the three and nine months ended September 30, 2009.

NOTE 3 – AGENCY MORTGAGE BACKED SECURITIES

The following table presents the components of the Company’s investment in Agency MBS as of September 30, 2010 and December 31, 2009:

	September 30, 2010									December 31, 2009
	CMBS			RMBS			TOTAL			CMBS		RMBS			TOTAL
Principal/par value	$	95,862		$	541,275		$	637,137		$	–	$	570,215		$	570,215
Premiums		9,709			18,909			28,618			–		12,991			12,991
Discounts		–			(37	)		(37	)		–		(44	)		(44	)
Amortized cost		105,571			560,147			665,718			–		583,162			583,162
Gross unrealized gains		2,515			9,712			12,227			–		11,261			11,261
Gross unrealized losses		(51	)		(1,051	)		(1,102	)		–		(303	)		(303	)
Fair value	$	108,035		$	568,808		$	676,843		$	–	$	594,120		$	594,120

Weighted average coupon		5.63	%		4.23	%		4.46	%		n/a		4.76	%		4.76	%

Principal/par value includes principal payments receivable of $3,391 and $3,559 on Agency MBS as of September 30, 2010 and December 31, 2009, respectively. The Company received principal payments of $179,262 on its portfolio of Agency MBS and purchased approximately $284,065 of Agency MBS during the nine months ended September 30, 2010. The Company also sold $18,762 of Agency MBS during the nine months ended September 30, 2010 on which it recognized gains of $702.

NOTE 4 – NON-AGENCY MBS

The following table presents the components of the Company’s non-Agency MBS as of September 30, 2010 and December 31, 2009:

	September 30, 2010									December 31, 2009
	CMBS			RMBS			TOTAL			CMBS			RMBS			TOTAL
Principal/par value	$	205,531		$	17,446		$	222,977		$	114,103		$	7,705		$	121,808
Premiums		3,273			154			3,427			4,177			–			4,177
Discounts		(11,234	)		(1,148	)		(12,382	)		(13,727	)		(1,243	)		(14,970	)
Amortized cost		197,570			16,452			214,022			104,553			6,462			111,015
Gross unrealized gains		11,210			593			11,803			2,795			416			3,211
Gross unrealized losses		–			(454	)		(454	)		(4,145	)		(971	)		(5,116	)
Fair value	$	208,780		$	16,591		$	225,371		$	103,203		$	5,907		$	109,110

Weighted average coupon		6.95	%		5.10	%		6.81	%		7.96	%		7.93	%		7.96	%

The Company’s non-Agency CMBS are comprised primarily of investment-grade rated securities with a fair value of $203,820 and $99,092, as of September 30, 2010 and December 31, 2009, respectively. The Company purchased non-Agency CMBS with a par value of $134,932 during the nine months ended September 30, 2010 and sold non-Agency CMBS with a par value of $30,765 for which it recognized a gain of $77 during the nine months ended September 30, 2010.

The Company also purchased non-Agency RMBS with a par value of $11,988 during the nine months ended September 30, 2010, which have a fair value of $11,375 as of September 30, 2010.

NOTE 5 – SECURITIZED MORTGAGE LOANS, NET

The following table summarizes the components of securitized mortgage loans as of September 30, 2010 and December 31, 2009:

	September 30, 2010			December 31, 2009
Securitized mortgage loans:
Commercial, unpaid principal balance	$	104,418		$	137,567
Single-family, unpaid principal balance		56,518			61,336
		160,936			198,903
Funds held by trustees, including funds held for defeasance		3,499			17,737
Unamortized discounts and premiums, net		322			43
Loans, at amortized cost		164,757			216,683
Allowance for loan losses		(3,862	)		(4,212	)
	$	160,895		$	212,471

All of the securitized mortgage loans are pledged as collateral for the associated 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 81% of commercial mortgage loans are secured by multifamily properties and approximately 19% 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 as of September 30, 2010 include $1,444 of

loans in foreclosure and $1,554 of loans more than 90 days delinquent on which the Company continues to accrue interest.

The Company identified securitized commercial and single-family mortgage loans with combined unpaid principal balances of $12,473 and $3,829 respectively, as being impaired as of September 30, 2010, compared to impairments of $20,491 and $4,065, respectively, as of December 31, 2009. The Company recognized $135 and $416 of interest income on impaired securitized commercial mortgage loans and $56 and $169 on impaired single-family mortgage loans for the three and nine months ended September 30, 2010, respectively.

Funds held by trustees as of September 30, 2010 and December 31, 2009 include $3,351 and $17,588, respectively, of cash and cash equivalents held by the trust for defeased commercial mortgage loans. These funds represent replacement collateral for defeased mortgage loans, which attempts to replicate the contractual cash flows of the defeased mortgage loans in accordance with the underlying agreements, and will be used as available 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 September 30, 2010 and December 31, 2009:

	September 30, 2010		December 31, 2009
Securitized commercial mortgage loans	$	3,593	$	3,935
Securitized single-family mortgage loans		269		277
		3,862		4,212
Other investments		–		96
	$	3,862	$	4,308

The following table presents certain information on impaired single-family and commercial securitized mortgage loans as of September 30, 2010 and December 31, 2009:

	September 30, 2010						December 31, 2009
	Commercial			Single-family			Commercial			Single-family
Investment in impaired loans, including basis adjustments	$	12,421		$	3,892		$	20,465		$	4,152
Allowance for loan losses		(3,593	)		(269	)		(3,935	)		(277	)
Investment in excess of allowance	$	8,828		$	3,623		$	16,530		$	3,875

The following tables summarize the aggregate activity for the portion of the allowance for loan losses that relates to the securitized mortgage loan portfolio for the three and nine months ended September 30, 2010 and September 30, 2009:

	Three Months Ended September 30, (1)
	2010						2009
	Commercial			Singe-family			Commercial			Singe-family
Allowance at beginning of period	$	3,709		$	271		$	3,660		$	261
Provision for loan losses		194			–			150			98
Credit losses, net of recoveries		(310	)		(2	)		(25	)		(113	)
Allowance at end of period	$	3,593		$	269		$	3,785		$	246

(1)

Activity shown excludes provision of $16 and credit losses of $(281) for the three months ended September 30, 2010 related to the Company’s unsecuritized mortgage loan portfolio. There was no activity related to the allowance for loan losses for the Company’s unsecuritized mortgage loan portfolio for the three months ended September 30, 2009.

	Nine Months Ended September 30, (1)
	2010						2009
	Commercial			Singe-family			Commercial			Singe-family
Allowance at beginning of period	$	3,935		$	277		$	3,527		$	180
Provision for loan losses		584			–			283			187
Credit losses, net of recoveries		(926	)		(8	)		(25	)		(121	)
Allowance at end of period	$	3,593		$	269		$	3,785		$	246

(1)	Activity shown excludes provision of $185 and credit losses of $(281) for the nine months ended September 30, 2010 and provision of $95 for the nine months ended September 30, 2009 related to the Company’s unsecuritized mortgage loan portfolio.

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 September 30, 2010 and December 31, 2009:

Type of Derivative	Balance Sheet Location	Gross Fair Value As of September 30, 2010			Gross Fair Value As of December 31, 2009
Interest rate swaps	Derivative assets	$	–		$	1,008
Interest rate swaps	Derivative liabilities		(4,889	)		–
		$	(4,889	)	$	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 September 30, 2010:

Maturity Date	Effective Date	Notional Amount		Fixed Rate Swapped
November 24, 2011	November 24, 2009	$	25,000		0.96	%
February 8, 2012	February 8, 2010		75,000		1.03	%
November 24, 2012	November 24, 2009		50,000		1.53	%
May 8, 2014	May 10, 2010		35,000		1.93	%
December 24, 2014	December 24, 2009		30,000		2.50	%
		$	215,000

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 September 30, 2010 or December 31, 2009. As of September 30, 2010, the Company had margin requirements for these interest rate swaps totaling $5,537 for which Agency MBS with a fair value of $4,822 and cash of $894 have been posted as collateral.

The table below presents the effect of the derivatives designated as hedging instruments on the Company’s consolidated statement of income for the three months ended September 30, 2010. The Company did not hold any derivative financial instruments during the three months ended September 30, 2009.

Type of Derivative Designated as Cash Flow Hedge	Amount of Loss Recognized in OCI (Effective Portion)	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 (Ineffective Portion)	Amount of Loss Recognized in Statement of Income (Ineffective Portion)
Interest rate swaps	$2,699	Interest expense	$651	Other income, net	$6

The table below presents the effect of the derivatives designated as hedging instruments on the Company’s consolidated statement of income for the nine months ended September 30, 2010. The Company did not hold any derivative financial instruments during the nine months ended September 30, 2009.

Type of Derivative Designated as Cash Flow Hedge	Amount of Loss Recognized in OCI (Effective Portion)	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 (Ineffective Portion)	Amount of Loss Recognized in Statement of Income (Ineffective Portion)
Interest rate swaps	$7,587	Interest expense	$1,706	Other income, net	$15

The table below presents the effect of the Company’s derivatives designated as hedging instruments on the Company’s accumulated other comprehensive income for the three and nine months ended September 30, 2010.

	Three Months Ended			Nine Months Ended
	September 30, 2010			September 30, 2010
Balance at beginning of period	$	(2,825	)	$	1,008
Change in fair value of interest rate swaps		(2,699	)		(7,587	)
Reclassification adjustment for amounts included in statement of operations		651			1,706
Balance at end of period	$	(4,873	)	$	(4,873	)

The Company estimates that an additional $2,549 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 one dollar 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 September 30, 2010, the Company had derivatives in a net liability position totaling $4,992, inclusive of accrued interest but excluding any adjustment for nonperformance risk, for which it had pledged collateral of $5,716 to its derivative counterparties. If the Company had breached any of these agreements as of September 30, 2010, it could have been required to settle those derivatives at their termination value of $4,992.

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 September 30, 2010 and December 31, 2009 by the type of securities collateralizing the repurchase agreement:

	September 30, 2010
Collateral Type	Balance		Weighted Average Rate			Fair Value of Collateral Pledged
Agency MBS	$	561,217		0.29	%	$	588,327
Non-Agency CMBS		100,108		1.67	%		117,450
Non-Agency RMBS		13,027		1.39	%		14,614
Securitization financing bonds (see Note 9)		70,795		1.30	%		84,849
	$	745,147		0.59	%	$	805,240

	December 31, 2009
Collateral Type	Balance		Weighted Average Rate			Fair Value of Collateral Pledged
Agency MBS	$	540,586		0.60	%	$	575,386
Non-Agency MBS		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 September 30, 2010 and December 31, 2009, the repurchase agreements had the following original maturities:

Original Maturity	September 30, 2010		December 31, 2009
30 days or less	$	373,864	$	69,576
31 to 60 days		110,705		300,413
61 to 90 days		87,445		180,643
Greater than 90 days		173,133		87,697
	$	745,147	$	638,329

As of September 30, 2010, the maximum amount of equity at risk under repurchase agreements with any individual counterparty is $17,144.

NOTE 9 – NON-RECOURSE COLLATERIZED FINANCING

Non-recourse collateralized financing on the Company’s consolidated balance sheet as of September 30, 2010 is comprised of $57,396 of securitization financing and $50,631 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”). 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 both non-recourse to the Company.

During the nine months ended September 30, 2010, the Company used the TALF financing to purchase ‘AAA’-rated CMBS with a par value of $60,800. The fair value of these CMBS as of September 30, 2010 is $65,029. The TALF financing has an estimated weighted average life remaining of 2.4 years and a weighted-average interest rate of 2.73%.

As of September 30, 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 which is owned by third parties and one of which has been retained by the Company. The class owned by third parties has a principal amount outstanding of $22,360 as of September 30, 2010 compared to $23,852 as of December 31, 2009 and is collateralized by single-family mortgage loans with unpaid principal balances of $23,068 as of September 30, 2010 compared to $24,563 as of December 31, 2009. As of September 30, 2010, this class shares additional collateralization of $6,549 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 $23,669 as of September 30, 2010 compared to $121,168 as of December 31, 2009, and is collateralized by commercial mortgage loans, including proceeds from defeased loans, with unpaid principal balances of $99,382 as of September 30, 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 September 30, 2010 and is collateralized by CMBS with a fair value of $16,958. This series represents the portion of a securitization bond the Company sold 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.

The components of securitization financing along with certain other information as of September 30, 2010 and December 31, 2009 are summarized as follows:

	September 30, 2010						December 31, 2009
	Bonds Outstanding			Range of Interest Rates			Bonds Outstanding			Range of Interest Rates
Fixed rate classes	$	38,669			6.2% – 7.2	%	$	121,168			6.7% - 7.2	%
Variable rate class		22,360			0.6	%		23,852			0.5	%
Unamortized net bond premium and deferred costs		(3,633	)					(1,939	)
	$	57,396					$	143,081

Weighted average coupon		4.5	%					5.9	%
Range of stated maturities		2016 – 2027						2024 – 2027
Estimated weighted average life	3.7 years						3.0 years

The Company has redeemed securitization bonds in the past, and in certain instances, the Company has kept the bond outstanding and used them as collateral for additional repurchase agreement borrowings.

These additional borrowings may have been used to either finance the bond redemption or to purchase additional investments. Although these bonds are legally outstanding, the balances are eliminated in consolidation because the issuing trust in included in the Company’s consolidated financial statements.

In August 2010, the Company redeemed $56.4 million of securitization financing that it had issued in 1997 with commercial mortgage loans as collateral, and replaced it with thirty-day repurchase agreement financing. The effective rate on the redeemed securitization financing of 8.76% was replaced with an effective rate on the repurchase agreement financing of 1.26%, yielding a net interest savings of 7.50%. If future market conditions are attractive, the Company may redeem part or all of the callable CMBS securitization financing remaining in the 1997 series.

The following table summarizes information regarding all of the Company’s outstanding redeemed bonds as of September 30, 2010:

Portion of Series Redeemed	Collateral Type	Par Value Outstanding		Fair Value		Repurchase Agreement Balance
1993 Trust	Commercial mortgage loans	$	3,781	$	3,781	$	3,067
2002 Trust	Single-family mortgage loans		26,901		24,043		21,909
1997 Trust	Commercial mortgage loans		55,854		57,025		45,819
		$	86,536	$	84,849	$	70,795

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, certain non-Agency CMBS, 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 MBS and delinquent property tax receivables.

The following table presents the fair value of the Company’s assets and liabilities as of September 30, 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	$	676,843	$	–	$	676,843	$	–
Non-Agency MBS:
CMBS		208,780		–		65,029		143,751
RMBS		16,591		–		–		16,591
Other investments		132		–		–		132
Total assets carried at fair value	$	902,346	$	–	$	741,872	$	160,474

Liabilities:
Derivative liabilities	$	4,889	$	–	$	4,889	$	–
Total liabilities carried at fair value	$	4,889	$	–	$	4,889	$	–

The Company’s Agency MBS, as well a portion of its non-Agency CMBS, are substantially similar to securities that either are currently actively traded or have been recently traded in their respective market. Their fair values are derived from an average of multiple dealer quotes and thus are considered Level 2 fair value measurements.

The Company’s remaining non-Agency CMBS and non-agency RMBS are comprised of securities for which there are not substantially similar securities that trade frequently. As such, the Company determines the fair value of 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 those pricing models are Level 3 in nature due to the lack of readily available market quotes. Information utilized in those pricing models include the security’s credit rating, coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected credit losses, 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 and nine months ended September 30, 2010:

	Level 3 Fair Values
	Non-Agency CMBS			Non-Agency RMBS			Other		Total assets
Balance as of June 30, 2010	$	111,530		$	5,330		$	131	$	116,991
Total realized and unrealized gains (losses):
Included in the statement of operations		–			–			1		1
Included in other comprehensive income		756			53			–		809
Purchases		43,367			11,671			–		55,038
Principal payments		(11,535	)		(484	)		–		(12,019	)
(Amortization) accretion		(367	)		21			–		(346	)
Transfers in and/or out of Level 3		–			–			–		–
Balance as of September 30, 2010	$	143,751		$	16,591		$	132	$	160,474

	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		(77	)		–			–			(77	)
Included in other comprehensive income		8,690			695			–			9,385
Purchases		74,695			11,671			11			86,377
Sales		(31,328	)		–			–			(31,328	)
Principal payments		(25,394	)		(1,711	)		(10	)		(27,115	)
(Amortization) accretion		(962	)		29			–			(933	)
Transfers in and/or out of Level 3		–			–			–			–
Balance as of September 30, 2010	$	143,751		$	16,591		$	132		$	160,474

The following table presents the recorded basis and estimated fair values of the Company’s financial instruments as of September 30, 2010 and December 31, 2009:

	September 30, 2010				December 31, 2009
	Recorded Basis		Fair Value		Recorded Basis		Fair Value
Assets:
Agency MBS	$	676,843	$	676,843	$	594,120	$	594,120
Non-Agency CMBS		208,780		208,780		103,203		103,203
Non-Agency RMBS		16,591		16,591		5,907		5,907
Securitized mortgage loans, net		160,895		148,230		212,471		186,547
Other investments		1,437		1,303		2,280		2,079
Derivative assets		–		–		1,008		1,008

Liabilities:
Repurchase agreements		745,147		745,147		638,329		638,329
Non-recourse collateralized financing		108,027		107,182		143,081		132,234
Derivative liabilities		4,889		4,889		–		–

There were no assets or liabilities which were measured at fair value on a non-recurring basis as of September 30, 2010 or December 31, 2009.

The following table presents certain information for Agency MBS and non-Agency MBS that were in an unrealized loss position as of September 30, 2010 and December 31, 2009:

	September 30, 2010				December 31, 2009
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Unrealized loss position for:
Less than one year:
Agency MBS	$	137,712	$	1,102	$	73,288	$	302
Non-Agency MBS		11,388		87		92,438		4,145
One year or more:
Non-Agency MBS		3,638		366		4,087		971
	$	152,738	$	1,555	$	169,813	$	5,418

The Company reviews the estimated future cash flows for its non-Agency MBS to determine whether there have been adverse changes in the cash flows that necessitate recognition of other-than-temporary impairment amounts. Approximately $3,554 of the non-Agency MBS in an unrealized loss position as of September 30, 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 September 30, 2010.

The estimated cash flows of the remaining $11,472 of non-Agency MBS were reviewed based on the performance of the underlying mortgage loans collateralizing the MBS as well as projected loss and prepayment rates. Based on that review, 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 September 30, 2010.

NOTE 11 – PREFERRED AND COMMON STOCK

The Company has a continuous equity placement program (“EPP”) whereby the Company may offer and sell through its sales agent 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. During the nine months ended September 30, 2010, the Company has received proceeds of $43,309, net of broker sales commission, for 4,680,700 shares of common stock sold at an average price of $9.44. On June 24, 2010, the Company filed a prospectus supplement with the SEC to offer and sell through its sales agent, JMP Securities, LLC, up to 5,000,000 shares of its common stock.

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 a portion of the Chief Executive Officer’s 2010 salary through September 30, 2010.

The following table presents a summary of the changes in the number of preferred and common shares outstanding for the period indicated:

	Preferred Stock Series D			Common Stock
Balance as of December 31, 2009		4,221,539			13,931,512
Common stock issued under EPP		-			4,680,700
Common stock redeemed under 2004 Stock and Incentive Plan		-			50,000
Common stock issued under 2009 Stock and Incentive Plan		-			47,030
Voluntary conversion of preferred shares to common shares		(152	)		152
Balance as of September 30, 2010		4,221,387			18,709,394

On September 9, 2010, the Company declared preferred and common dividends of $0.25 each to be paid on October 29, 2010 to shareholders of record on September 30, 2010.

On September 13, 2010, the Company announced that its Board of Directors had authorized the Company to redeem all 4,221,539 of the outstanding shares of the Company’s Series D 9.50% Cumulative Convertible Preferred Stock (the “Series D Preferred Stock”) pursuant to provisions of the Company’s articles of incorporation. Subsequent to this announcement and prior to September 30, 2010, 152 shares of Series D Preferred Stock were voluntarily converted, leaving 4,221,387 shares of Series D Preferred Stock to be redeemed. Please see Note 15 regarding activity related to this redemption which occurred subsequent to September 30, 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, 2,452,970 shares remain available as of September 30, 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) thereunder as of September 30, 2010.

SARs issued by the Company may be settled only in cash, and therefore have been treated as liability awards with their fair value measured at the grant date and remeasured at the end of each reporting period as required by ASC Topic 718. As of September 30, 2010 and December 31, 2009, the fair value of the Company’s outstanding SARs of $463 and $447, respectively, are recorded as liabilities on its consolidated balance sheet for the respective periods. The weighted average remaining contractual term on the SARs outstanding as of September 30, 2010 is 27 months. The total remaining compensation cost related to non-vested SARs is $13 as of September 30, 2010 and will be recognized as the awards vest. The fair value of SARs was estimated as of September 30, 2010 and December 31, 2009 using the Black-Scholes option valuation model based upon the assumptions in the table below.

September 30, 2010