Edgar Filing: ANNALY CAPITAL MANAGEMENT INC

a6494953.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2010

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER: 1-13447

ANNALY CAPITAL MANAGEMENT, INC.

(Exact name of Registrant as specified in its Charter)

MARYLAND	22-3479661
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

1211 AVENUE OF THE AMERICAS, SUITE 2902

NEW YORK, NEW YORK

(Address of principal executive offices)

10036

(Zip Code)

(212) 696-0100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all documents and 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 x 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 x No o

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

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

Class	Outstanding at November 5, 2010
Common Stock, $.01 par value	621,878,208

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS

Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Financial Condition at September 30, 2010 (Unaudited) and December 31, 2009 (Derived from the audited consolidated statement of financial condition at December 31, 2009)	1

Consolidated Statements of Operations and Comprehensive Income (Unaudited) for the quarters and nine months ended September 30, 2010 and 2009	2

Consolidated Statement of Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2010	3
Consolidated Statements of Cash Flows (Unaudited) for the quarters and nine months ended September 30, 2010 and 2009	4

Notes to Consolidated Financial Statements (Unaudited)	5

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk	44

Item 4. Controls and Procedures	45

Part II. OTHER INFORMATION

Item 1. Legal Proceedings	46

Item 1A. Risk Factors	46

Item 6. Exhibits	46

SIGNATURES	48

Part I

Item 1. Financial Statements

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in thousands)

	September 30, 2010 (Unaudited)			December 31, 2009(1)
ASSETS
Cash and cash equivalents	$	289,486		$	1,504,568
U.S. Treasury securities, at fair value		754,993			-
Reverse repurchase agreements with affiliate		-			328,757
Reverse repurchase agreements		757,722			425,000
Mortgage-Backed Securities, at fair value		76,174,141			64,805,725
Agency debentures, at fair value		2,046,371			915,752
Investment with affiliates		245,659			242,198
Securities borrowed		251,242			29,077
Receivable for Mortgage Backed Securities Sold		1,637,542			732,134
Accrued interest and dividends receivable		345,153			318,919
Receivable from Prime Broker		3,272			3,272
Receivable for advisory and service fees		15,138			12,566
Intangible for customer relationships, net		9,590			10,491
Goodwill		27,917			27,917
Interest rate swaps, at fair value		-			5,417
Other derivative contracts, at fair value		186			-
Other assets		26,351			14,397
Total assets	$	82,584,763		$	69,376,190

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Repurchase agreements	$	61,040,668		$	54,598,129
Payable for Mortgage-Backed Securities and Agency debentures purchased		8,165,941			4,083,786
Convertible Senior Notes		600,000			-
U.S. Treasury Securities sold, not yet purchased, at fair value		691,593			-
Accrued interest payable		113,837			89,460
Dividends payable		422,036			414,851
Securities loaned		251,332			29,057
Accounts payable and other liabilities		51,440			10,005
Interest rate swaps, at fair value		1,604,639			533,362
Total liabilities		72,941,486			59,758,650

6.00% Series B Cumulative Convertible Preferred Stock: 4,600,000 shares authorized, 2,306,537 and 2,604,614 shares issued and outstanding, respectively		55,891			63,114

Commitments and contingencies		-			-

Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, 7,412,500 shares issued and outstanding		177,088			177,088
Common stock, par value $.01 per share, 987,987,500 shares authorized, 620,640,708 and 553,134,877 shares issued and outstanding, respectively		6,206			5,531
Additional paid-in capital		8,994,954			7,817,454
Accumulated other comprehensive income		1,877,537			1,891,317
Accumulated deficit		(1,468,399	)		(336,964	)
Total stockholders’ equity		9,587,386			9,554,426

Total liabilities, Series B Cumulative Convertible Preferred Stock and stockholders’ equity	$	82,584,763		$	69,376,190

(1) Derived from the audited consolidated financial statements at December 31, 2009.

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(dollars in thousands, except per share amounts)

(Unaudited)

	For the Quarter Ended September 30, 2010			For the Quarter Ended September 30, 2009			For the Nine Months Ended September 30, 2010			For the Nine Months Ended September 30, 2009
Interest income
Mortgage-Backed Securities and agency debentures	$	700,964		$	744,523		$	1,997,681		$	2,170,939
Securities loaned		1,261			-			2,575			-
U.S. Treasury Securities		751			-			791			-

Total interest income		702,976			744,523			2,001,047			2,170,939

Interest expense
Repurchase agreements		105,393			124,653			294,457			474,235
Interest rate swaps		188,636			183,124			545,009			534,763
Convertible Senior Notes		7,033			-			17,194			-
Securities borrowed		1,047			-			2,176			-
U.S. Treasury Securities sold, not yet purchased		459			-			483			-
Total interest expense		302,568			307,777			859,319			1,008,998

Net interest income		400,408			436,746			1,141,728			1,161,941
Other (loss) income
Investment advisory and service fees		15,343			14,620			41,752			34,117
Gain on sale of Mortgage-Backed Securities and agency debentures		61,986			591			147,989			7,978
Dividend income		8,097			5,398			23,391			9,537
Unrealized (loss) gain on interest rate swaps		(448,253	)		(128,687	)		(1,158,023	)		137,065
Net gain on trading securities		1,082			-			1,159			-
Income from underwriting		915			-			1,415			-
Total other (loss) income		(360,830	)		(108,078	)		(942,317	)		188,697

Expenses
Distribution fees		-			478			360			1,338
General and administrative expenses		43,430			33,344			124,991			93,272
Total expenses		43,430			33,822			125,351			94,610

(Loss) income before income from equity method investments and income taxes		(3,852	)		294,846			74,060			1,256,028

Income from equity method investment		868			-			1,943			-

Income taxes		(11,076	)		(9,657	)		(27,227	)		(23,892	)

Net (loss) income		(14,060	)		285,189			48,776			1,232,136

Dividends on preferred stock		4,515			4,625			13,765			13,876

Net (loss) income (related) available to common shareholders	$	(18,575	)	$	280,564		$	35,011		$	1,218,260

Net (loss) income (related) available per share to common shareholders:
Basic	$	(0.03	)	$	0.51		$	0.06		$	2.24
Diluted	$	(0.03	)	$	0.51		$	0.06		$	2.22

Weighted average number of common shares outstanding:
Basic		611,904,518			547,611,480			575,742,043			544,970,392
Diluted		611,904,518			553,376,285			575,958,563			550,913,871

Net (loss) income	$	(14,060	)	$	285,189		$	48,776		$	1,232,136
Other comprehensive (loss) income:
Unrealized (loss) gain on available-for-sale securities		(619,080	)		542,396			52,880			1,538,587
Unrealized gain on interest rate swaps		18,402			56,055			81,329			177,155
Reclassification adjustment for net gains included in net income		(61,986	)		(591	)		(147,989	)		(7,978	)
Other comprehensive (loss) income		(662,664	)		597,860			(13,780	)		1,707,764
Comprehensive (loss) income	$	(676,724	)	$	883,049		$	34,996		$	2,939,900

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2010

(dollars in thousands, except per share data)

(Unaudited)

	Preferred Stock		Common Stock Par Value		Additional Paid-In Capital		Accumulated Other Comprehensive Income			Accumulated Deficit			Total
BALANCE, DECEMBER 31, 2009	$	177,088	$	5,531	$	7,817,454	$	1,891,317		$	(336,964	)	$	9,554,426

Net income		-		-		-		-			48,776			-
Other comprehensive loss		-		-		-		(13,780	)		-			-
Comprehensive income		-		-		-		-			-			34,996
Net proceeds from follow-on offering		-		600		1,046,793		-			-			1,047,393
Exercise of stock options		-		2		2,841		-			-			2,843
Stock option expense and long-term compensation expense		-		-		3,562		-			-			3,562
Conversion of Series B cumulative preferred stock		-		7		7,215		-			-			7,222
Net proceeds from direct purchase and dividend reinvestment		-		66		117,089		-			-			117,155
Preferred Series A dividends declared $1.4766 per share		-		-		-		-			(10,945	)		(10,945	)
Preferred Series B dividends declared $1.125 per share		-		-		-		-			(2,820	)		(2,820	)
Common dividends declared $2.01 per share		-		-		-		-			(1,166,446	)		(1,166,446	)

BALANCE, SEPTEMBER 30, 2010	$	177,088	$	6,206	$	8,994,954	$	1,877,537		$	(1,468,399	)	$	9,587,386

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)

	For the Quarter Ended September 30, 2010			For the Quarter Ended September 30, 2009			For the Nine Months Ended September 30, 2010			For the Nine Months Ended September 30, 2009
Cash flows from operating activities:
Net income (loss)	$	(14,060	)	$	285,189		$	48,776		$	1,232,136
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of Mortgage-Backed Securities and agency debentures premiums and discounts, net		155,868			75,072			457,052			174,502
Amortization of intangibles		407			407			1,220			1,909
Deferred expense amortization		900			-			2,250			-
Gain on sale of Mortgage-Backed Securities and agency debentures		(61,986	)		(591	)		(147,989	)		(7,978	)
Stock option and long-term compensation expense		1,196			938			3,562			2,871
Unrealized loss (gain) on interest rate swaps		448,253			128,687			1,158,023			(137,065	)
Net gains on trading securities		(1,082	)		-			(1,159	)		-
Net change in investment with affiliate, equity method		(97	)		11			(312	)		11
Increase in accrued interest and dividend receivable		(22,272	)		(25,357	)		(24,303	)		(47,542	)
Decrease (increase) in other assets		15,308			(3,455	)		3,477			(2,972	)
(Increase) in advisory and service fees receivable		(1,779	)		(2,768	)		(2,573	)		(6,704	)
Increase (decrease) in interest payable		14,471			(4,968	)		24,376			(102,291	)
Increase (decrease) in accounts payable and other liabilities		17,536			(2,124	)		41,347			29,609
Payments on repurchase agreements from Broker Dealer		(364,576,286	)		(167,933,399	)		(930,904,601	)		(191,536,573	)
Proceeds from repurchase agreements from Broker Dealer		365,003,080			172,113,103			936,383,970			199,146,573
Payments on reverse repurchase agreements from Broker Dealer		(21,376,914	)		(1,528,392	)		(30,153,996	)		(2,165,602	)
Proceeds from reverse repurchase agreements from Broker Dealer		20,927,968			1,402,637			2,9891,027			1,992,414
Payments on securities borrowed		(886,755	)		-			(2,212,011	)		-
Proceeds from securities borrowed		877,755			-			1,989,846			-
Payments on securities loaned		(987,876	)		-			(2,144,516	)		-
Proceeds from securities loaned		996,966			-			2,366,791			-
Purchase of trading securities		(3,081,852	)		-			(3,523,995	)		-
Proceeds from sale of trading securities		3,080,309			-			3,461,601			-
Net cash provided by operating activities		529,058			4,504,990			6,717,863			8,573,298
Cash flows from investing activities:
Purchase of Mortgage-Backed Securities		(12,662,901	)		(8,805,661	)		(35,951,636	)		(20,472,665	)
Proceeds from sale of Mortgage-Backed Securities and agency debentures		1,284,437			605,911			5,516,172			1,635,844
Principal payments of Mortgage-Backed Securities		5,569,728			4,016,331			22,307,773			10,031,023
Agency debentures called		349,875			-			1,223,875			602,000
Purchase of agency debentures		-			-			(2,827,666	)		(623,361	)
Payments on reverse repurchase agreements		-			(5,070,260	)		(4,032,426	)		(5,643,179	)
Proceeds from reverse repurchase agreements		-			5,040,667			4,291,430			6,052,222
Purchase of available-for-sale equity securities from affiliate		-			-			-			(90,078	)
Purchase of equity securities		-			(67,917	)					(67,917	)
Net cash used in investing activities		(5,458,861	)		(4,280,929	)		(9,472,478	)		(8,576,111	)
Cash flows from financing activities:
Proceeds from repurchase agreements		55,726,371			80,062,824			166,732,844			262,419,462
Principal payments on repurchase agreements		(51,499,332	)		(79,726,618	)		(165,769,674	)		(260,861,509	)
Net proceeds from follow-on offering		1,047,393						1,047,393
Issuance of convertible notes		-			-			582,000			-
Proceeds from exercise of stock options		1,032			320			2,843			1,043
Proceeds from direct purchase and dividend reinvestment		997			141,189			117,155			141,189
Dividends paid		(385,151	)		(331,233	)		(1,173,028	)		(883,384	)
Net cash provided by financing activities		4,891,310			146,482			1,539,533			816,801
Net (decrease) increase in cash and cash equivalents		(38,493	)		370,543			(1,215,082	)		813,988
Cash and cash equivalents, beginning of period		327,979			1,352,798			1,504,568			909,353
Cash and cash equivalents, end of period	$	289,486		$	1,723,341		$	289,486		$	1,723,341

Supplemental disclosure of cash flow information:
Interest paid	$	288,097		$	312,746		$	834,943		$	1,111,290
Taxes paid	$	11,330		$	9,616		$	27,938		$	29,264

Noncash investing activities:
Receivable for Mortgage-Backed Securities sold	$	1,637,542			-		$	1,637,542			-
Payable for Mortgage-Backed Securities and agency debentures purchased	$	8,165,941		$	3,644,420		$	8,165,941		$	3,644,420
Net change in unrealized (loss) gain on available-for-sale securities and interest rate swaps, net of reclassification adjustment	$	(662,664	)	$	597,860		$	(13,780	)	$	1,707,764

Noncash financing activities:
Dividends declared, not yet paid	$	422,036		$	381,411		$	422,036		$	381,411
Conversion of Series B cumulative preferred stock	$	7,206		$	3		$	7,222		$	32,928
See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR QUARTERS ENDED SEPTEMBER 30, 2010 AND 2009

(Unaudited)

1.	ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Annaly Capital Management, Inc. (“Annaly” or the “Company”) was incorporated in Maryland on November 25, 1996. The Company commenced its operations of purchasing and managing an investment portfolio of mortgage-backed securities on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital, and completed its initial public offering on October 14, 1997. The Company is a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended. Fixed Income Discount Advisory Company (“FIDAC”) is a registered investment advisor and is a wholly owned taxable REIT subsidiary of the Company. During the third quarter of 2008, the Company formed RCap Securities, Inc. (“RCap” or “Broker Dealer”). RCap was granted membership in the Financial Industry Regulatory Authority (“FINRA”) on January 26, 2009, and operates as a broker-dealer. RCap is a wholly owned taxable REIT subsidiary of the Company. On October 31, 2008, the Company acquired Merganser Capital Management, Inc. (“Merganser”). Merganser is a registered investment advisor and is a wholly owned taxable REIT subsidiary of the Company.

A summary of the Company’s significant accounting policies follows:

Basis of Presentation - The accompanying unaudited consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, they may not include all of the information and footnotes required by accounting principles generally accepted in the United States of America ("GAAP").

The consolidated interim financial statements are unaudited; however, in the opinion of the Company's management, all adjustments, consisting only of normal recurring accruals, necessary for a fair statement of the financial condition, results of operations, and cash flows have been included. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2009. The nature of the Company's business is such that the results of any interim period are not necessarily indicative of results for a full year. The consolidated financial statements include the accounts of the Company, FIDAC, Merganser and RCap. All intercompany balances and transactions have been eliminated.

Prior quarter numbers were reclassified in the financial statements to conform with the current quarter presentation.

Cash and Cash Equivalents - Cash and cash equivalents include cash on hand and cash held in money market funds on an overnight basis.

Reverse Repurchase Agreements - The Company may invest its daily available cash balances via reverse repurchase agreements to provide additional yield on its assets. These investments will typically be recorded as short term investments and will generally mature daily. Reverse repurchase agreements are recorded at cost and are collateralized by mortgage-backed securities pledged by the counterparty to the agreement. Reverse repurchase agreements entered into by RCap are part of the subsidiary’s daily matched book trading activity. These reverse repurchase agreements are recorded on trade date at the contract amount, are collateralized by mortgage backed securities and generally mature within 90 days. Margin calls are made by RCap as appropriate based on the daily valuation of the underlying collateral versus the contract price. RCap generates income from the spread between what is earned on the reverse repurchase agreements and what is paid on the matched repurchase agreements. Cash flows related to RCap’s matched book activity are included in cash flows from operating activity.

Securities borrowed and loaned transactions – RCap records securities borrowed and loaned transactions at the amount of cash collateral advanced or received. Securities borrowed transactions require RCap to provide the counterparty with collateral in the form of cash or other securities. RCap receives collateral in the form of cash or other securities for securities loaned transactions. For these transactions, the fees received or paid by RCap are recorded as interest income or expense. On a daily basis, market value changes of securities borrowed or loaned against may require counterparties to deposit additional collateral or return collateral pledged, when appropriate.

U.S. Treasury Securities - During the second quarter 2010, RCap commenced trading U.S. Treasury securities for its proprietary portfolio, which consists of long and short positions on U.S Treasury bills, notes, and bonds. U.S. Treasury securities are classified as trading investments and are recorded on trade date at cost. Changes in fair value are reflected in the Company’s statement of operations. U.S Treasury bills trade at a discount to par with the difference between proceeds received upon maturity and purchase price recognized as interest income in the Company’s statement of operations. Interest income on U.S Treasury notes and bonds is accrued based on the outstanding principal amount of those investments and their contractual terms. Premiums and discounts associated with the purchase of the U.S. Treasury notes and bonds are amortized into interest income over the projected lives of the securities using the interest method.

Mortgage-Backed Securities and Agency Debentures – The Company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans, and certificates guaranteed by the Government National Mortgage Association (“Ginnie Mae”) , the Federal Home Loan Mortgage Corporation (“Freddie Mac”) or the Federal National Mortgage Association (“Fannie Mae”) (collectively, “Mortgage-Backed Securities”). The Company also invests in agency debentures issued by Federal Home Loan Bank (“FHLB”), Freddie Mac, and Fannie Mae.

Investment Securities – The Mortgage-Backed Securities, agency debentures, U.S. treasury securities, securities borrowed, and equity securities are referred to herein as “Investment Securities.” The Company is required to classify its Investment Securities as either trading investments, available-for-sale investments or held-to-maturity investments. Although the Company generally intends to hold most of its Investment Securities until maturity, it may, from time to time, sell any of its Investment Securities as part of its overall management of its portfolio. All assets classified as available-for-sale are reported at estimated fair value, based on market prices from independent sources, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. The Company’s investment in Chimera Investment Corporation (“Chimera”) is accounted for as available-for-sale equity securities. The Company’s investment in CreXus Investment Corp. (“CreXus”) is accounted for under the equity method.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The Company determines if it (1) has the intent to sell the Investment Securities, (2) is more likely than not that it will be required to sell the securities before recovery, or (3) does not expect to recover the entire amortized cost basis of the Investment Securities. Further, the security is analyzed for credit loss (the difference between the present value of cash flows expected to be collected and the amortized cost basis). The credit loss, if any, will then be recognized in the statement of operations, while the balance of impairment related to other factors will be recognized in other comprehensive income (“OCI”). There were no losses on other-than-temporarily impaired securities for the quarters and nine months ended September 30, 2010 and 2009.

The estimated fair value of available-for-sale debt and equity securities, U.S Treasury securities, receivable from prime broker, interest rate swaps, and futures and options contracts is equal to their carrying value presented in the consolidated statements of financial condition. Cash and cash equivalents, reverse repurchase agreements, securities borrowed, receivable for Mortgage-Backed Securities sold, accrued interest and dividends receivable, receivable for advisory and service fees, repurchase agreements with maturities shorter than one year, payable for Investment Securities purchased, securities loaned, dividends payable, accounts payable and other liabilities, and accrued interest payable, generally approximates fair value at September 30, 2010 due to the short term nature of these financial instruments. The estimated fair value of long term structured repurchase agreements is reflected in Note 9 to the financial statements.

Interest income is accrued based on the outstanding principal amount of the Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Investment Securities are amortized into interest income over the projected lives of the securities using the interest method. The Company’s policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, consensus prepayment speeds, and current market conditions. Dividend income on available-for-sale equity securities is recorded on the ex-date on an accrual basis.

Investment Securities transactions are recorded on the trade date. Purchases of newly-issued securities are recorded when all significant uncertainties regarding the characteristics of the securities are removed, generally shortly before settlement date. Realized gains and losses on sales of Investment Securities are determined on the specific identification method.

Derivative Financial Instruments/Hedging Activity - Prior to the fourth quarter of 2008, the Company designated interest rate swaps as cash flow hedges, whereby the swaps were recorded at fair value on the balance sheet as assets and liabilities with any changes in fair value recorded in OCI. In a cash flow hedge, a swap would exactly match the pricing date of the relevant repurchase agreement. Through the end of the third quarter of 2008 the Company continued to be able to effectively match the swaps with the repurchase agreements therefore entering into effective hedge transactions. However, due to the volatility of the credit markets, it was no longer practical to match the pricing dates of both the swaps and the repurchase agreements.

As a result, the Company voluntarily discontinued hedge accounting after the third quarter of 2008 through a combination of de-designating previously defined hedge relationships and not designating new contracts as cash flow hedges. The de-designation of cash flow hedges requires that the net derivative gain or loss related to the discontinued cash flow hedge should continue to be reported in accumulated OCI, unless it is probable that the forecasted transaction will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter. The Company continues to hold repurchase agreements in excess of swap contracts and has no indication that interest payments on the hedged repurchase agreements are in jeopardy of discontinuing. Therefore, the deferred losses related to these derivatives that have been de-designated will not be recognized immediately and will remain in OCI. These losses are reclassified into earnings during the contractual terms of the swap agreements starting as of October 1, 2008. Changes in the unrealized gains or losses on the interest rate swaps subsequent to September 30, 2008 are reflected in the Company’s statement of operations.

RCap enters into U.S Treasury, Eurodollar, and federal funds futures and options contracts for speculative or hedging purposes. RCap maintains a margin account which is settled daily with futures and options commission merchants. Changes in the unrealized gains or losses on the futures and options contracts are reflected in the Company’s statement of operations.

Credit Risk – The Company has limited its exposure to credit losses on its portfolio of Mortgage-Backed Securities by only purchasing securities issued by Freddie Mac, Fannie Mae or Ginnie Mae and agency debentures issued by the FHLB, Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae Mortgage-Backed Securities are guaranteed by those respective agencies, and the payment of principal and interest on the Ginnie Mae Mortgage-Backed Securities are backed by the full faith and credit of the U.S. government. Principal and interest on agency debentures are guaranteed by the agency issuing the debenture. Substantially all of the Company’s Investment Securities have an actual or implied “AAA” rating. The Company faces credit risk on the portions of its portfolio which are not Mortgage-Backed Securities and agency debentures.

Market Risk - Weakness in the mortgage market could adversely affect one or more of the Company’s lenders and could cause one or more of the Company’s lenders to be unwilling or unable to provide additional financing. This could potentially increase the Company’s financing costs and reduce liquidity. If one or more major market participants fails, it could negatively impact the marketability of all fixed income securities, including Mortgage-Backed Securities. This could negatively impact the value of the securities in the Company’s portfolio, thus reducing its net book value. Furthermore, if many of the Company’s lenders are unwilling or unable to provide additional financing, the Company could be forced to sell its Mortgage-Backed Securities and agency debentures at an inopportune time when prices are depressed. The Company does not anticipate having difficulty converting its assets to cash or extending financing terms due to the fact that its Mortgage-Backed Securities and agency debentures have an actual or implied “AAA” rating and principal payment is guaranteed by Freddie Mac, Fannie Mae, or Ginnie Mae.

Repurchase Agreements - The Company finances the acquisition of its Mortgage-Backed Securities and agency debentures through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Reverse repurchase agreements and repurchase agreements with the same counterparty and the same maturity are presented net in the statement of financial condition when the terms of the agreements permit netting.

Convertible Senior Notes – The Company records the notes at their contractual amounts, including accrued interest. The Company has analyzed whether the embedded conversion option should be bifurcated and has determined that bifurcation is not necessary.

Cumulative Convertible Preferred Stock - The Series B Cumulative Convertible Preferred Stock (the “Series B Preferred Stock”) contains fundamental change provisions that allow the holder to redeem the Series B Preferred Stock for cash if certain events occur. As redemption under these provisions is not solely within the Company’s control, the Company has classified the Series B Preferred Stock as temporary equity in the accompanying consolidated statements of financial condition. The Company has analyzed whether the embedded conversion option should be bifurcated and has determined that bifurcation is not necessary.

Income Taxes - The Company has elected to be taxed as a REIT and intends to comply with the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), with respect thereto. Accordingly, the Company will not be subjected to federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and stock ownership tests are met. The Company and each of its subsidiaries, FIDAC, Merganser and RCap have made separate joint elections to treat the subsidiaries as taxable REIT subsidiaries. As such, each of the taxable REIT subsidiaries are taxable as a domestic C corporation and subject to federal, state, and local income taxes based upon its taxable income.

Use of Estimates - The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. All assets classified as available-for-sale and interest rate swaps are reported at their estimated fair value, based on market prices. The Company’s policy is to obtain fair values from one or more independent sources. Fair values from independent sources are compared to internal prices for reasonableness. Actual results could differ from those estimates.

Goodwill and Intangible Assets - The Company’s acquisitions of FIDAC and Merganser were accounted for using the purchase method. Under the purchase method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. In addition, the costs of FIDAC and Merganser were allocated to the assets acquired, including identifiable intangible assets, and the liabilities assumed based on their estimated fair values at the date of acquisition. The excess of purchase price over the fair value of the net assets acquired was recognized as goodwill. Goodwill and intangible assets are periodically (but not less frequently than annually) reviewed for potential impairment. Intangible assets with an estimated useful life are expected to amortize over a 10.2 year weighted average time period. During the quarters and nine months ended September 30, 2010, and 2009, there were no impairment losses.

Stock Based Compensation - The Company is required to measure and recognize in the consolidated financial statements the compensation cost relating to share-based payment transactions. The compensation cost is reassessed based on the fair value of the equity instruments issued.

The Company recognizes compensation expense on a straight-line basis over the requisite service period for the entire award (that is, over the requisite service period of the last separately vesting portion of the award). The Company estimated fair value using the Black-Scholes valuation model.

A Summary of Recent Accounting Pronouncements Follows:

Assets

Receivables (ASC 310)

In July 2010, the FASB released ASU 2010-20, which addresses disclosures about the credit quality of financing receivables and the allowance for credit losses. The purpose of this update is to provide greater transparency regarding the allowance for credit losses and the credit quality of financing receivables as well as to assist in the assessment of credit risk exposures and evaluation of the adequacy of allowances for credit losses. Additional disclosures must be provided on a disaggregated basis. The update defines two levels of disaggregation – portfolio segment and class of financing receivable. Additionally, the update requires disclosure of credit quality indicators, past due information and modifications of financing receivables. The update is not applicable to mortgage banking activities (loans originated or purchased for resale to investors); derivative instruments such as repurchase agreements; debt securities; a transferor’s interest in securitization transactions accounted for as sales under ASC 860; and purchased beneficial interests in securitized financial assets. This update is effective for the Company for interim or annual periods ending on or after December 15, 2010. This update will have no material effect on the Company’s consolidated financial statements.

Broad Transactions

Consolidation (ASC 810)

Effective January 1, 2010, the consolidation standards have been amended by ASU 2009-17. This amendment updates the existing standard and eliminates the exemption from consolidation of a Qualified Special Purpose Entity (“QSPE”). The update requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity (“VIE”). The analysis identifies the primary beneficiary of a VIE as the enterprise that has both: a) the power to direct the activities that most significantly impact the entity’s economic performance and b) the obligation to absorb losses or the right to receive benefits from the entity which could potentially be significant to the VIE. The update requires enhanced disclosures to provide users of financial statements with more transparent information about an enterprises involvement in a VIE. Further, ongoing assessments of whether an enterprise is the primary beneficiary of a VIE are required. At this time, the amendment has no material effect on the Company’s consolidated financial statements.

Effective January 1, 2010, FASB amended the consolidation standard with ASU 2010-10 which indefinitely defers the effective date of ASU 2009-17 for a reporting enterprises interest in entities for which it is industry practice to issue financial statements in accordance with investment company standards (ASC 946). This deferral is expected to most significantly affect reporting entities in the investment management industry. This amendment has no material effect on the Company’s consolidated financial statements.

Fair Value Measurements and Disclosures (ASC 820)

In September 2009, FASB issued guidance (ASU 2009-12) on measuring the fair value of certain alternative investments. This guidance offers investors a practical expedient for measuring the fair value of investments in certain entities that calculate net asset value (NAV) per share. If an investment falls within the scope of the ASU, the reporting entity is permitted, but not required to use the investment’s NAV to estimate its fair value. This guidance has no material effect on the fair valuation of the Company’s assets. The Company does not hold any assets qualifying under this guidance.

In January 2010, FASB issued guidance (ASU 2010-06) which increased disclosure regarding the fair value of assets. The key provisions of this guidance include the requirement to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 including a description of the reason for the transfers. Previously this was only required of transfers between Level 2 and Level 3 assets. Further, reporting entities are required to provide fair value measurement disclosures for each class of assets and liabilities; a class is potentially a subset of the assets or liabilities within a line item in the statement of financial position. Additionally, disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements are required for either Level 2 or Level 3 assets. This portion of the guidance was effective for the Company on December 31, 2009. The guidance also requires that the disclosure on any Level 3 assets presents separately information about purchases, sales, issuances and settlements. In other words, Level 3 assets are presented on a gross basis rather than as one net number. However, this last portion of the guidance is not effective for the Company until December 31, 2010. Adoption of this guidance results in increased disclosure in the notes to the Company’s financial statements

Subsequent Events (ASC 855)

ASC 855 provides general standards governing accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued.

In February 2010, FASB issued ASU 2010-09 as an amendment to ASC 855. This update eliminates the requirement to provide a specific date through which subsequent events were evaluated. This update was issued to alleviate potential conflicts between ASC 855 and SEC reporting requirements. The update was effective upon issuance and has no impact on the Company’s consolidated financial statements.

Transfers and Servicing (ASC 860)

On June 12, 2009, the FASB issued ASU 2009-16, which amended the accounting standards governing the transfer and servicing of financial assets. This amendment updates the existing standard and eliminates the concept of a Qualified Special Purpose Entity (“QSPE”); clarifies the surrendering of control to effect sale treatment; and modifies the financial components approach – limiting the circumstances in which a financial asset or portion thereof should be derecognized when the transferor maintains continuing involvement. It defines the term “Participating Interest”. Under this standard update, the transferor must recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of a transfer, including any retained beneficial interest. Additionally, the amendment requires enhanced disclosures regarding the transferors risk associated with continuing involvement in any transferred assets. The amendment was effective beginning January 1, 2010. The Company believes the amendment will have no material effect on the consolidated financial statements.

2. MORTGAGE-BACKED SECURITIES

The following tables present the Company’s available-for-sale Mortgage-Backed Securities portfolio as of September 30, 2010 and December 31, 2009 which were carried at their fair value:

September 30, 2010	Federal Home Loan Mortgage Corporation			Federal National Mortgage Association			Government National Mortgage Association			Total Mortgage- Backed Securities
	(dollars in thousands)
Mortgage-Backed
Securities, gross	$	20,625,317		$	50,564,185		$	891,087		$	72,080,589
Unamortized discount		(13,179	)		(16,989	)		-			(30,168	)
Unamortized premium		512,159			1,753,361			27,893			2,293,413
Amortized cost		21,124,297			52,300,557			918,980			74,343,834

Gross unrealized gains		554,750			1,430,221			33,848			2,018,819
Gross unrealized losses		(30,309	)		(158,201	)		(2	)		(188,512	)

Estimated fair value	$	21,648,738		$	53,572,577		$	952,826		$	76,174,141

	Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Estimated Fair Value
	(dollars in thousands)

Adjustable rate	$	11,807,581		$	322,885		$	(23,666	)	$	12,106,800

Fixed rate		62,536,253			1,695,934			(164,846	)		64,067,341

Total	$	74,343,834		$	2,018,819		$	(188,512	)	$	76,174,141

December 31, 2009	Federal Home Loan Mortgage Corporation			Federal National Mortgage Association			Government National Mortgage Association			Total Mortgage- Backed Securities
	(dollars in thousands)
Mortgage-Backed
Securities, gross	$	18,973,616		$	41,836,554		$	779,109		$	61,589,279
Unamortized discount		(20,210	)		(28,167	)		-			(48,377	)
Unamortized premium		301,700			974,861			20,382			1,296,943
Amortized cost		19,255,106			42,783,248			799,491			62,837,845

Gross unrealized gains		717,749			1,318,066			21,944			2,057,759
Gross unrealized losses		(27,368	)		(61,739	)		(772	)		(89,879	)

Estimated fair value	$	19,945,487		$	44,039,575		$	820,663		$	64,805,725

	Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Estimated Fair Value
	(dollars in thousands)
Adjustable rate	$	16,345,988		$	513,820		$	(68,488	)	$	16,791,320

Fixed rate		46,491,857			1,543,939			(21,391	)		48,014,405

Total	$	62,837,845		$	2,057,759		$	(89,879	)	$	64,805,725

Actual maturities of Mortgage-Backed Securities are generally shorter than stated contractual maturities because actual maturities of Mortgage-Backed Securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepayments of principal. The following table summarizes the Company’s Mortgage-Backed Securities on September 30, 2010 and December 31, 2009, according to their estimated weighted-average life classifications:

	September 30, 2010				December 31, 2009
Weighted-Average Life	Fair Value		Amortized Cost		Fair Value		Amortized Cost
	(dollars in thousands)
Less than one year	$	2,320,970	$	2,283,449	$	2,796,707	$	2,762,873
Greater than one year and less than five years		64,528,094		62,865,355		55,780,372		54,070,493
Greater than or equal to five years		9,325,077		9,195,030		6,228,646		6,004,479

Total	$	76,174,141	$	74,343,834	$	64,805,725	$	62,837,845

The weighted-average lives of the Mortgage-Backed Securities at September 30, 2010 and December 31, 2009 in the table above are based upon data provided through subscription-based financial information services, assuming constant principal prepayment rates to the reset date of each security. The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, mortgage rate of the outstanding loans, loan age, margin and volatility. The actual weighted average lives of the Mortgage-Backed Securities could be longer or shorter than estimated.

The following table presents the gross unrealized losses, and estimated fair value of the Company’s Mortgage-Backed Securities by length of time that such securities have been in a continuous unrealized loss position at September 30, 2010 and December 31, 2009.

	Unrealized Loss Position For: (dollars in thousands)
	Less than 12 Months					12 Months or More					Total
	Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses
September 30, 2010	$	8,886,626	$	(186,174	)	$	197,258	$	(2,338	)	$	9,083,884	$	(188,512	)

December 31, 2009	$	4,818,239	$	(22,869	)	$	2,802,920	$	(67,010	)	$	7,621,159	$	(89,879	)

The decline in value of these securities is solely due to market conditions and not the quality of the assets. Substantially all of the Mortgage-Backed Securities are “AAA” rated or carry an implied “AAA” rating. The investments are not considered other-than-temporarily impaired because the Company currently has the ability and intent to hold the investments to maturity or for a period of time sufficient for a forecasted market price recovery up to or beyond the cost of the investments. Also, the Company is guaranteed payment of the principal amount of the securities by the government agency which created them.

During the quarter and nine months ended September 30, 2010, the Company sold $2.8 billion and $5.8 billion of Mortgage-Backed Securities, resulting in a realized gain of $61.9 million and $146.6 million, respectively. During the quarter and nine months ended September 30, 2009, the Company sold $194.3 million and $1.6 billion of Mortgage-Backed Securities, resulting in a realized gain of $591,000 and $8.0 million, respectively.

3. AGENCY DEBENTURES

At September 30, 2010, the Company owned agency debentures with a carrying value of $2.0 billion, including an unrealized gain of $36.3 million. At December 31, 2009, the Company owned agency debentures with a carrying value of $915.8 million including an unrealized loss of $3.0 million.

During the quarter and nine months ended September 30, 2010, the Company sold or had called $350.0 million and $1.7 billion of agency debentures, resulting in realized gains of $125,000 and $1.3 million, respectively. The Company had no sales of agency debentures for the quarter and nine months ended September 30, 2009.

4. INVESTMENT WITH AFFILIATE, AVAILABLE FOR SALE EQUITY SECURITIES

All of the available-for-sale equity securities are shares of Chimera and are reported at fair value. The Company owned approximately 45.0 million shares of Chimera at a fair value of approximately $177.7 million at September 30, 2010 and approximately 45.0 million shares of Chimera at fair value of approximately $174.5 million at December 31, 2009. At September 30, 2010 and December 31, 2009, the investment in Chimera had an unrealized gain of $38.8 million and $35.7 million, respectively. Chimera is externally managed by FIDAC pursuant to a management agreement.

5. INVESTMENT WITH AFFILIATE, EQUITY METHOD

The Company owns approximately 25% of CreXus and accounts for its investment using the equity method. CreXus is externally managed by FIDAC pursuant to a management agreement. The quoted fair value of the Company’s investment in CreXus was $54.5 and $63.2 million at September 30, 2010 and December 31, 2009, respectively.

6. REVERSE REPURCHASE AGREEMENTS

At September 30, 2010, the Company did not have any amounts outstanding under its reverse repurchase agreement with Chimera. At December 31, 2009, the Company had lent $259.0 million to Chimera in a reverse repurchase agreement which was callable weekly. This amount was included in the principal amount which approximates fair value in the Company’s Statements of Financial Condition. The interest rate at December 31, 2009 was at the rate of 1.72%. The collateral for this loan was mortgage-backed securities with a fair value of $314.3 million at December 31, 2009.

At September 30, 2010, RCap had outstanding reverse repurchase agreements with non-affiliates of $757.7 million. At December 31, 2009, RCap, in its ordinary course of business, financed through matched reverse repurchase agreements, at market rates, $69.7 million for an entity that is managed by FIDAC pursuant to a management agreement. At December 31, 2009, RCap had an outstanding reverse repurchase agreement with non-affiliates of $425.0 million.

The Company reports cash flows on reverse repurchase agreements as investment activities in the Statements of Cash Flows. Cash flows related to RCap’s reverse repurchase agreements activities are reported as operating activities in the Statements of Cash Flows.

7. RECEIVABLE FROM PRIME BROKER

The net assets of the investment fund owned by the Company are subject to English bankruptcy law, which governs the administration of Lehman Brothers International (Europe) (in administration) (“LBIE”), as well as the law of New York, which governs the contractual documents. The Company invested approximately $45.0 million in the fund and has redeemed approximately $56.0 million. The current assets of the fund still remain at LBIE and affiliates of LBIE and the ultimate recovery of such amount remains uncertain. The Company has entered into the Claims Resolution Agreement (the “CRA”) between LBIE and certain eligible offerees effective December 29, 2009 with respect to these assets.

Certain of the fund’s assets subject to the CRA are held directly at LBIE and the Company has valued such assets in accordance with the valuation date set forth in the CRA and the pricing information provided to the Company by LBIE. The valuation date with respect to these assets as set forth in the CRA is September 19, 2008.

Certain of the fund’s assets subject to the CRA are not held directly at LBIE and are believed to be held at affiliates of LBIE. Given the great degree of uncertainty as to the status of the fund’s assets that are not directly held by LBIE and are believed to be held at affiliates of LBIE, the Company has valued such assets at an 80% discount, or $3.3 million. The value of the net assets that are not directly held by LBIE and are believed to be held at affiliates of LBIE is determined on the basis of the best information available to us from time to time, legal and professional advice obtained for the purpose of determining the rights, and on the basis of a number of assumptions which we believe to be reasonable.

The Company can provide no assurance, however, that it will recover all or any portion of any of the net assets of the fund following completion of LBIE’s administration (and any subsequent liquidation).

8. FAIR VALUE MEASUREMENTS

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

Level 1– inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in active markets.

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – inputs to the valuation methodology are unobservable and significant to overall fair value.

Available for sale equity securities, U.S. Treasury securities, and futures and options contracts are valued based on quoted prices (unadjusted) in an active market. Mortgage-Backed Securities and interest rate swaps are valued using quoted prices for similar assets and dealer quotes. The dealer will incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, rate reset period and expected life of the security. Management ensures that current market conditions are represented. Management compares similar market transactions and comparisons to a pricing model. The Mortgage-Backed Securities and agency debentures characteristics are as follows:

	Weighted Average Coupon on Fixed Rate Securities	Weighted Average Coupon on Adjustable Rate Securities	Weighted Average Yield on Fixed Rate Securities	Weighted Average Yield on Adjustable Rate Securities	Weighted Average Lifetime Cap on Adjustable Rate Securities	Weighted Average Term to Next Adjustment on Adjustable Rate Securities

At September 30, 2010	5.06%	4.33%	4.10%	2.27%	10.04%	38 months

At December 31, 2009	5.78%	4.55%	4.95%	3.23%	10.09%	33 months

The Company’s financial assets and liabilities carried at fair value on a recurring basis are valued as follows:

	Level 1		Level 2		Level 3
At September 30, 2010	(dollars in thousands)
Assets:
Mortgage-Backed Securities	$	-	$	76,174,141		-
Agency debentures		-		2,046,371		-
Investment with affiliate		177,682		-		-
U.S. Treasury securities		754,993		-		-
Securities borrowed		251,242		-		-
Other derivative contracts		186		-		-
Liabilities:
Interest rate swaps		-		1,604,639		-
U.S. Treasury securities sold, not yet purchased		691,593		-		-
Securities loaned		251,332		-		-

At December 31, 2009
Assets:
Mortgage-Backed Securities	$	-	$	64,805,725		-
Agency debentures		-		915,752		-
Investment with affiliate		174,533		-		-
Interest rate swaps		-		5,417		-
Liabilities:
Interest rate swaps		-		533,362		-

The classification of assets and liabilities by level remains unchanged at September 30, 2010, when compared to the previous quarter.

9. REPURCHASE AGREEMENTS

The Company had outstanding $61.0 billion and $54.6 billion of repurchase agreements with weighted average borrowing rates of 1.94% and 2.11%, after giving effect to the Company’s interest rate swaps, and weighted average remaining maturities of 144 days and 170 days as of September 30, 2010 and December 31, 2009, respectively. Mortgage-Backed Securities and agency debentures pledged as collateral under these repurchase agreements and interest rate swaps had an estimated fair value of $65.7 billion at September 30, 2010 and $57.9 billion at December 31, 2009.

At September 30, 2010 and December 31, 2009, the repurchase agreements had the following remaining maturities:

	September 30, 2010		December 31, 2009
	(dollars in thousands)
1 day	$	4,807,326	$	-
2 to 29 days		26,297,059		38,341,206
30 to 59 days		10,726,047		7,163,255
60 to 89 days		2,596,970		192,005
90 to 119 days		8,314,013		139,966
Over 120 days		8,299,253		8,761,697
Total	$	61,040,668	$	54,598,129

The Company did not have an amount at risk greater than 10% of the equity of the Company with any counterparty as of September 30, 2010 or December 31, 2009.

The Company has entered into structured term repurchase agreements which provide the counterparty with the right to call the balance prior to maturity date. These repurchase agreements totaled $6.6 billion and the fair value of the option to call was ($410.8 million) at September 30, 2010. The repurchase agreements totaled $7.0 billion and the fair value of the option to call was ($352.4 million) at December 31, 2009. Management has determined that the call option is not required to be bifurcated as it is deemed clearly and closely related to the debt instrument, therefore the fair value of the option is not recorded in the consolidated financial statements.

The structured term repurchase agreements are modeled and priced such that the Company pays fixed interest rates to the counterparty and receives floating interest rates. The counterparty has the option to cancel the swap after an initial lockout period. Therefore the structured repurchase agreements are priced as a combination of an interest rate swap with an embedded call option.

Additionally, as of September 30, 2010 the Company has entered into a repurchase agreement with a term of over one year. The amount of the repurchase agreement is $500 million and it has an estimated fair value of ($22.3 million).

The Company reports cash flows from repurchase agreements as financing activities in the Statements of Cash Flows. Cash flows related to RCap’s repurchase agreement activities are reported as operating activities in the Statements of Cash Flows.

10. DERIVATIVE INSTRUMENTS

In connection with the Company’s interest rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts. As of September 30, 2010, such instruments are comprised of interest rate swaps, which in effect modify the cash flows on repurchase agreements. The use of interest rate swaps creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts. In the event of a default by the counterparty, the Company could have difficulty obtaining its Mortgage-Backed Securities pledged as collateral for swaps. The Company does not anticipate any defaults by its counterparties.

The Company’s swaps are used to lock in the fixed rate related to a portion of its current and anticipated future 30-day term repurchase agreements.

In connection with RCap’s proprietary trading activities, it has entered into U.S. Treasury, Eurodollar, and federal funds futures and options contracts for speculative or hedging purposes. RCap invests in futures and options contracts for economic hedging purposes to reduce exposure to changes in yields of its U.S Treasury securities and for speculative purposes to achieve capital appreciation. The use of futures and options contracts creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts. RCap executes these trades as a customer of an appropriately licensed futures and options broker dealer.

The location and fair value of derivative instruments reported in the Consolidated Statement of Financial Condition as of September 30, 2010 and December 31, 2009 are as follows:

	Location on Statement of Financial Condition	Notional Amount			Net Estimated Fair Value/Carrying Value
	(dollars in thousands)
Interest rate swaps
September 30, 2010	Liabilities		$	25,879,100	$	(1,604,639	)
September 30, 2010	Assets			-		-
December 31, 2009	Liabilities		$	18,823,300	$	(533,362	)
December 31, 2009	Assets		$	2,700,000	$	5,417

Other derivative contracts
September 30, 2010	Liabilities		-
September 30, 2010	Assets	$	186

The effect of derivatives on the Statement of Operations and Comprehensive Income is as follows:

	Interest Expense		Unrealized (Loss) Gain
	(dollars in thousands)
Interest rate swaps
For the Quarter Ended September 30, 2010	$	188,636	$	(448,253	)
For the Quarter Ended September 30, 2009	$	183,124	$	(128,687	)
For the Nine Months Ended September 30, 2010	$	545,009	$	(1,158,023	)
For the Nine Months Ended September 30, 2009	$	534,763	$	137,065

	Realized Loss			Unrealized Gain (Loss)
Other derivative contracts	(dollars in thousands)
For the Quarter Ended September 30, 2010	$	(1,248	)	$	91
For the Nine Months Ended September 30, 2010	$	(2,266	)	$	(125	)

The weighted average pay rate on the Company’s interest rate swaps at September 30, 2010 was 3.34% and the weighted average receive rate was 0.31%. The weighted average pay rate at September 30, 2009 was 3.98% and the weighted average receive rate was 0.28%.

11. CONVERTIBLE SENIOR NOTES

During the nine months ended September 30, 2010, the Company issued $600.0 million in aggregate principal amount of its 4% Convertible Senior Notes due 2015 (“Convertible Senior Notes”) for net proceeds following expenses of approximately $582.0 million. Interest on the Convertible Senior Notes is paid semi-annually at a rate of 4% per year and the Convertible Senior Notes will mature on February 15, 2015 unless earlier repurchased or converted. The Convertible Senior Notes are convertible into shares of Common Stock at an initial conversion rate and conversion rate at September 30, 2010 of 46.6070 and 52.2040, respectively, shares of Common Stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price of approximately $21.4560 and a conversion price of September 30, 2010 of approximately $19.1556 per share of Common Stock, subject to adjustment in certain circumstances. The market value at September 30, 2010 was $661.3 million, based on closing price.

12. PREFERRED STOCK AND COMMON STOCK

(A)	Common Stock Issuances

On July 13, 2010 the Company entered into an agreement pursuant to which it sold 60,000,000 shares of its common stock for net proceeds following underwriting expenses of approximately $1.0 billion. This transaction settled on July 19, 2010.

During the quarter and nine months ended September 30, 2010, 79,000 and 227,000 options were exercised under the Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise price of $1.0 million and $2.8 million, respectively.

During the quarter and nine months ended September 30, 2010, 297,000 and 298,000 shares of Series B Preferred Stock were converted into 741,000 and 743,000 shares of common stock, respectively.

During the quarter and nine months ended September 30, 2010, the Company raised $691,000 and $117.2 million by issuing 39,000 and 6.6 million shares, respectively, through the Direct Purchase and Dividend Reinvestment Program.

During the year ended December 31, 2009, 423,160 options were exercised under the Incentive Plan for an aggregate exercise price of $4.9 million. During the year ended December 31, 2009, 7,550 shares of restricted stock were issued under the Incentive Plan.

During the year ended December 31, 2009, 1.4 million shares of Series B Preferred Stock were converted into 2.8 million shares of common stock.

During the year ended December 31, 2009, the Company raised $141.8 million by issuing 8.4 million shares, through the Direct Purchase and Dividend Reinvestment Program.

(B) Preferred Stock

At September 30, 2010 and December 31, 2009, the Company had issued and outstanding 7,412,500 shares of Series A Cumulative Redeemable Preferred Stock (“Series A Preferred Stock”), with a par value $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series A Preferred Stock must be paid a dividend at a rate of 7.875% per year on the $25.00 liquidation preference before the common stock is entitled to receive any dividends. The Series A Preferred Stock is redeemable at $25.00 per share plus accrued and unpaid dividends (whether or not declared) exclusively at the Company's option commencing on April 5, 2009 (subject to the Company's right under limited circumstances to redeem the Series A Preferred Stock earlier in order to preserve its qualification as a REIT). The Series A Preferred Stock is senior to the Company's common stock and is on parity with the Series B Preferred Stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series A Preferred Stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series A Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series A Preferred Stock, together with the Series B Preferred Stock, will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse changes to the terms of the Series A Preferred Stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series A Preferred Stock and Series B Preferred Stock. Through September 30, 2010, the Company had declared and paid all required quarterly dividends on the Series A Preferred Stock.

At September 30, 2010 and December 31, 2009, the Company had issued and outstanding 2,306,537 and 2,604,614 shares, respectively, of Series B Cumulative Convertible Preferred Stock (“Series B Preferred Stock”), with a par value $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series B Preferred Stock must be paid a dividend at a rate of 6% per year on the $25.00 liquidation preference before the common stock is entitled to receive any dividends.

The Series B Preferred Stock is not redeemable. The Series B Preferred Stock is convertible into shares of common stock at a conversion rate that adjusts from time to time upon the occurrence of certain events, including if the Company distributes to its common shareholders in any calendar quarter cash dividends in excess of $0.11 per share. Initially, the conversion rate was 1.7730 shares of common shares per $25 liquidation preference. At September 30, 2010 and December 31, 2009, the conversion ratio was 2.5784 and 2.3449 shares of common stock per $25 liquidation preference, respectively. Commencing April 5, 2011, the Company has the right in certain circumstances to convert each Series B Preferred Stock into a number of common shares based upon the then prevailing conversion rate. The Series B Preferred Stock is also convertible into common shares at the option of the Series B preferred shareholder at anytime at the then prevailing conversion rate. The Series B Preferred Stock is senior to the Company's common stock and is on parity with the Series A Preferred Stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series B Preferred Stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series B Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series B Preferred Stock, together with the Series A Preferred Stock, will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse changes to the terms of the Series B Preferred Stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series B Preferred Stock and Series A Preferred Stock. Through September 30, 2010, the Company had declared and paid all required quarterly dividends on the Series B Preferred Stock. During the quarter and nine months ended September 30, 2010, 297,000 and 298,000 shares of Series B Preferred Stock were converted into 741,000 and 743,000 shares of common stock, respectively. During the year ended December 31, 2009, 1.4 million shares of Series B Preferred Stock were converted into 2.8 million shares of common stock.

During the quarter and nine months ended September 30, 2010, the Company declared dividends to common shareholders totaling $422.0 million or $0.68 per share and $1.2 billion or $2.01 per share, respectively, of which $422.0 million was paid to shareholders on October 28, 2010. During the quarter and nine months ended September 30, 2010, the Company declared dividends to Series A Preferred shareholders totaling approximately $3.6 million or $0.492188 per share and $10.9 million or $1.4766 per share and Series B shareholders totaling approximately $867,000 or $0.375 per share and $2.8 million or $1.125, respectively.

During the quarter ended September 30, 2009, the Company declared dividends to common shareholders totaling $381.4 million or $0.69 per share, which were paid to shareholders on October 29, 2009. During the nine months ended September 30, 2009, the Company declared dividends to common shareholders totaling $980.2 million, or $1.79 per share. During the quarter and nine months ended September 30, 2009, the Company declared dividends to Series A Preferred shareholders totaling approximately $3.6 million or $0.492188 per share and $10.9 million or $1.476564 per share, respectively, and Series B shareholders totaling approximately $977,000 or $0.375 per share and $2.9 million or $1.125 per share, respectively.

13. NET INCOME PER COMMON SHARE

The following table presents a reconciliation of the net income and shares used in calculating basic and diluted earnings per share for the quarters and nine months ended September 30, 2010 and 2009.

	For the Quarters Ended September 30,					For the Nine Months Ended September 30,
	2010			2009		2010		2009
Net (loss) income (related) attributable to controlling interest	$	(14,060	)	$	285,189	$	48,776	$	1,232,136
Less: Preferred stock dividends		4,515			4,625		13,765		13,876
Net (loss) income (related) available to common shareholders, prior to adjustment for Series B dividends and Convertible Senior Notes interest, if necessary	$	(18,575	)	$	280,564	$	35,011	$	1,218,260
Add: Preferred Series B dividends, if Series B shares are dilutive		-			977		-		2,930
Net (loss) income (related) available to common shareholders, as adjusted	$	(18,575	)	$	281,541	$	35,011	$	1,221,190
Weighted average shares of common stock outstanding-basic		611,905			547,611		575,742		544,970
Add: Effect of dilutive stock options		-			48		217		227
Add: Effect of Series B Cumulative Convertible Preferred Stock		-			5,717		-		5,717
Weighted average shares of common stock outstanding-diluted		611,905			553,376		575,959		550,914

Options to purchase 572,000 and 566,000 shares of common stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the quarter and nine months ended September 30, 2010, respectively. Options to purchase 1.1 million and 4.5 million shares of common stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the quarter and nine months ended September 30, 2009, respectively.

14. LONG-TERM STOCK INCENTIVE PLAN

The Company has adopted a long term stock incentive plan for executive officers, key employees and non-employee directors (the “Incentive Plan”). The Incentive Plan authorized the Compensation Committee of the board of directors to grant awards, including non-qualified options as well as incentive stock options as defined under Section 422 of the Code. The Incentive Plan authorized the granting of options or other awards for an aggregate of the greater of 500,000 shares or 9.5% of the diluted outstanding shares of the Company’s common stock, up to ceiling of 8,932,921 shares. No further awards will be made under the Incentive Plan, although existing awards will remain effective. Stock options were issued at the current market price on the date of grant, subject to an immediate or four year vesting in four equal installments with a contractual term of 5 or 10 years. The grant date fair value is calculated using the Black-Scholes option valuation model.

On May 27, 2010, at the 2010 Annual Meeting of Stockholders of the Company, the stockholders approved the 2010 Equity Incentive Plan. The 2010 Equity Incentive Plan authorizes the Compensation Committee of the board of directors to grant options, stock appreciation rights, dividend equivalent rights, or other share-based award, including restricted shares up to an aggregate of 25,000,000 shares, subject to adjustments as provided in the 2010 Equity Incentive Plan. On June 28, 2010, the Company granted to each non-management director of the Company options to purchase 1,250 shares of the Company’s common stock under the 2010 Equity Incentive Plan. The stock options were issued at the current market price on the date of grant and immediately vested with a contractual term of 5 years. The grant date fair value is calculated using the Black-Scholes option valuation model.

	For the Nine Months Ended
	September 30, 2010					September 30, 2009
	Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price
Options outstanding at the beginning of period		7,271,503		$	15.20		5,180,164		$	15.87
Granted		7,500			17.24		2,537,000			13.26
Exercised		(226,791	)		12.54		(97,712	)		10.67
Forfeited		(14,400	)		14.85		(10,000	)		15.61
Expired		(6,250	)		18.26		(11,250	)		17.32
Options outstanding at the end of period		7,031,562		$	15.28		7,598,202		$	15.06
Options exercisable at the end of period		3,961,568		$	16.04		2,196,377		$	16.23

The weighted average remaining contractual term was approximately 6.9 years for stock options outstanding and approximately 5.8 years for stock options exercisable as of September 30, 2010. As of September 30, 2010, there was approximately $10.0 million of total unrecognized compensation cost related to nonvested share-based compensation awards. That cost is expected to be recognized over a weighted average period of 2.2 years.

The weighted average remaining contractual term was approximately 7.8 years for stock options outstanding and approximately 5.1 years for stock options exercisable as of September 30, 2009. As of September 30, 2009, there was approximately $14.4 million of total unrecognized compensation cost related to nonvested share-based compensation awards. That cost is expected to be recognized over a weighted average period of 3.2 years.

15. INCOME TAXES

As a REIT, the Company is not subject to federal income tax on earnings distributed to its shareholders. Most states recognize REIT status as well. The Company has decided to distribute the majority of its income and retain a portion of the permanent difference between book and taxable income arising from Section 162(m) of the Code pertaining to employee remuneration.

During the quarter and nine months ended September 30, 2010, the Company’s taxable REIT subsidiaries recorded $2.4 million and $5.4 million, respectively, of income tax expense for income attributable to those subsidiaries, and the portion of earnings retained based on Code Section 162(m) limitations. During the quarter and nine months ended September 30, 2010, the Company recorded $8.6 million and $21.8 million, respectively, of income tax expense for a portion of earnings retained based on Section 162(m) limitations. The effective tax rate was 52% for the nine months ended September 30, 2010.

During the quarter and nine months ended September 30, 2009, the Company’s taxable REIT subsidiaries recorded $3.3 million and $5.4 million, respectively, of income tax expense for income attributable to those subsidiaries, and the portion of earnings retained based on Code Section 162(m) limitations. During the quarter and nine months ended September 30, 2009, the Company recorded $6.4 million and $18.5 million, respectively, of income tax expense for a portion of earnings retained based on Section 162(m) limitations. The effective tax rate was 53% for the nine months ended September 30, 2009.

The effective tax rates were calculated based on the Company’s estimated taxable income after dividends paid deduction and differ from the federal statutory rate as a result of state and local taxes and permanent difference pertaining to employee remuneration as discussed above.

The statutory combined federal, state, and city corporate tax rate is 45%. This amount is applied to the amount of estimated REIT taxable income retained (if any, and only up to 10% of ordinary income as all capital gain income is distributed) and to taxable income earned at the taxable subsidiaries. Thus, as a REIT, the Company’s effective tax rate is significantly less as it is allowed to deduct dividend distributions.

16. LEASE COMMITMENTS AND CONTINGENCIES

Commitments

The Company has a non-cancelable lease for office space which commenced in May 2002 and expires in December 2015. Merganser has a non-cancelable lease for office space, which commenced on May 2003 and expires in May 2014. Merganser subleases a portion of its leased space to a subtenant. FIDAC has a lease for office space which commenced in October 2010 and expires in February 2016. The Company’s aggregate future minimum lease payments total $9.2 million. The following table details the lease payments.

Year Ending December	Lease Commitment		Sublease Income		Net Amount
	(dollars in thousands)
2010 (remaining)	$	573	$	42	$	531
2011		2,294		169		2,125
2012		2,294		70		2,224
2013		2,294		-		2,294
2014		1,866		-		1,866
Later years		192		-		192
	$	9,513	$	281	$	9,232

Contingencies

From time to time, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material effect on the Company’s consolidated financial statements and therefore no accrual is required as of September 30, 2010 and December 31, 2009.

Merganser’s prior owners may receive additional consideration under the merger agreement. The Company expects to pay approximately $14.1 million of this earn-out during the fourth quarter of 2010. The Company cannot currently calculate how much additional consideration will be paid under the earn-out provisions because the payment amount will vary depending upon whether and the extent to which Merganser achieves specific performance goals. The additional earn-out consideration will be paid during 2012 if Merganser meets specific performance goals under the merger agreement. All amounts paid under this provision will be recorded as additional goodwill.

17. INTEREST RATE RISK

The primary market risk to the Company is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company’s control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with the interest-bearing liabilities, by affecting the spread between the interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of the interest-earning assets and the Company’s ability to realize gains from the sale of these assets. A decline in the value of the Mortgage-Backed Securities and agency debentures pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. Liquidation of collateral at losses could have an adverse accounting impact, as discussed in Note 1.

The Company seeks to manage the extent to which net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. The Company may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in the portfolio of Mortgage-Backed Securities and agency debentures by entering into interest rate agreements such as interest rate caps and interest rate swaps. As of September 30, 2010 and December 31, 2009 the Company entered into interest rate swaps to pay a fixed rate and receive a floating rate of interest, with a total notional amount of $25.9 billion and $21.5 billion, respectively.

Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on Mortgage-Backed Securities. The Company will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets purchased at a premium with assets purchased at a discount. To date, the aggregate premium exceeds the aggregate discount on the Mortgage-Backed Securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce net income compared to what net income would be absent such prepayments.

18. RELATED PARTY TRANSACTIONS

At September 30, 2010, the Company had $14.3 billion of repurchase agreements outstanding with RCap. The weighted average interest rate is 0.34% and the terms are one to three months. These agreements are collateralized by Mortgage-Backed Securities, with an estimated market value of $15.0 billion. For the quarter and nine months ended September 30, 2010, RCap earned $13.6 and $32.5 million in interest income from the Company, respectively.

At December 31, 2009, the Company had lent $259.0 million to Chimera in a reverse repurchase agreement which was callable weekly. This amount is included in the principal amount which approximates fair value in the Company’s Statement of Financial Condition. The interest rate at December 31, 2009 was at the rate of 1.72%.

On April 15, 2009, the Company purchased approximately 25.0 million shares of Chimera common stock at a price of $3.00 for aggregate proceeds of approximately $74.9 million. On May 27, 2009, the Company purchased approximately 4.7 million shares of Chimera common stock at a price of $3.22 for aggregate proceeds of approximately $15.2 million. Chimera is managed by FIDAC, and the Company owned approximately 5.1% of Chimera's common stock at September 30, 2010.

On September 22, 2009, the Company acquired 4,527,778 shares of CreXus’s common stock at a price of $15.00 per share. The Company owns approximately 25% of CreXus at September 30, 2010 and accounts for its investment using the equity method.

RCap acted as a book-running manager in Chimera’s underwritten public offering of 115 million shares of its common stock, which was completed on June 28, 2010. In connection with this offering, RCap recognized income from underwriting of $500,000.

RCap acted as a book-running manager in the Company’s underwritten public offering of 60 million shares of its common stock, which was completed on July 19, 2010. In connection with this offering, RCap recognized income from underwriting of $915,000.

19. RCAP REGULATORY REQUIREMENTS

RCap is subject to regulations of the securities business that include but are not limited to trade practices, use and safekeeping of funds and securities, capital structure, recordkeeping, and conduct of directors, officers and employees.

As a self clearing, registered broker dealer, RCap is subject to the minimum net capital requirements of the Financial Industry Regulatory Authority (“FINRA”). As of September 30, 2010, RCap had a minimum net capital requirement of $753,000 and would be required to notify FINRA if capital was to fall below the early warning threshold of $904,000. RCap consistently operates with capital significantly in excess of its regulatory capital requirements. RCap’s regulatory net capital as defined by SEC Rule 15c3-1, as of September 30, 2010 was $178.9 million with excess net capital of $178.0 million.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements

Certain statements contained in this quarterly report, and certain statements contained in our future filings with the Securities and Exchange Commission (the "SEC" or the "Commission"), in our press releases or in our other public or shareholder communications may not be based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements, which are based on various assumptions, (some of which are beyond our control) may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, changes in interest rates, changes in the yield curve, changes in prepayment rates, the availability of mortgage-backed securities and other securities for purchase, the availability of financing, and, if available, the terms of any financings, changes in the market value of our assets, changes in business conditions and the general economy, changes in governmental regulations affecting our business, and our ability to maintain our classification as a REIT for federal income tax purposes, and risks associated with the investment advisory business of our subsidiaries, including the removal by their clients of assets they manage, their regulatory requirements, and competition in the investment advisory business, and risks associated with the broker dealer business of our subsidiary. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see our most recent Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q. We do not undertake and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Overview

We are a real estate investment trust, or REIT, that owns, manages, and finances a portfolio of real estate related investment securities, including mortgage pass-through certificates, collateralized mortgage obligations (or CMOs), agency callable debentures, and other securities representing interests in or obligations backed by pools of mortgage loans. Our principal business objective is to generate net income for distribution to our stockholders from the spread between the interest income on our interest-earning assets and the costs of borrowing to finance our acquisition of interest-earning assets and from dividends we receive from our subsidiaries. Our wholly-owned subsidiaries offer diversified real estate, asset management and other financial services. FIDAC and Merganser are our wholly-owned taxable REIT subsidiaries that are registered investment advisors that generate advisory and service fee income. RCap is our wholly-owned broker dealer taxable REIT subsidiary that generates fee income.

We are primarily engaged in the business of investing, on a leveraged basis, in mortgage pass-through certificates, CMOs and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans issued or guaranteed by Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae) and the Government National Mortgage Association (Ginnie Mae and together with Freddie Mac and Fannie Mae the Agencies) (collectively, Mortgage-Backed Securities). We also invest in Federal Home Loan Bank (FHLB), Freddie Mac and Fannie Mae debentures. The Mortgage-Backed Securities, agency debentures, U.S. treasury securities, securities borrowed, and equity securities are referred to herein as “Investment Securities.”

Under our capital investment policy, at least 75% of our total assets must be comprised of high-quality mortgage-backed securities and short-term investments. High quality securities means securities that (1) are rated within one of the two highest rating categories by at least one of the nationally recognized rating agencies, (2) are unrated but are guaranteed by the United States government or an agency of the United States government, or (3) are unrated but we determine them to be of comparable quality to rated high-quality mortgage-backed securities.

The remainder of our assets, comprising not more than 25% of our total assets, may consist of other qualified REIT real estate assets which are unrated or rated less than high quality, but which are at least “investment grade” (rated “BBB” or better by Standard & Poor’s Corporation (“S&P”) or the equivalent by another nationally recognized rating agency) or, if not rated, we determine them to be of comparable credit quality to an investment which is rated “BBB” or better. In addition, we may directly or indirectly invest part of this remaining 25% of our assets in other types of securities, including without limitation, unrated debt, equity or derivative securities, to the extent consistent with our REIT qualification requirements. The derivative securities in which we invest may include securities representing the right to receive interest only or a disproportionately large amount of interest, as well as inverse floaters, which may have imbedded leverage as part of their structural characteristics.

We may acquire Mortgage-Backed Securities backed by single-family residential mortgage loans as well as securities backed by loans on multi-family, commercial or other real estate related properties. To date, substantially all of the Mortgage-Backed Securities that we have acquired have been backed by single-family residential mortgage loans.

We have elected to be taxed as a REIT for federal income tax purposes. Pursuant to the current federal tax regulations, one of the requirements of maintaining our status as a REIT is that we must distribute at least 90% of our REIT taxable income (determined without regard to the deduction for dividends paid and by excluding any net capital gain) to our stockholders, subject to certain adjustments.

The results of our operations are affected by various factors, many of which are beyond our control. Our results of operations primarily depend on, among other things, our net interest income, the market value of our assets and the supply of and demand for such assets. Our net interest income, which reflects the amortization of purchase premiums and accretion of discounts, varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. Prepayment speeds, as reflected by the Constant Prepayment Rate, or CPR, and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment speeds on our Mortgage-Backed Securities portfolio increase, related purchase premium amortization increases, thereby reducing the net yield on such assets. The CPR on our Mortgage-Backed Securities and agency debentures portfolio averaged 20% and 21% for the quarters ended September 30, 2010 and 2009, respectively. Since changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to effectively manage interest rate risks and prepayment risks while maintaining our status as a REIT.

The table below provides quarterly information regarding our average balances, interest income, yield on assets, average interest-bearing liabilities, interest expense, cost of funds, net interest income and net interest rate spreads for the quarterly periods presented.

	Average Interest-Earning Assets (1)		Total Interest Income		Yield on Average Interest-Earning Assets			Average Interest-Bearing Liabilities		Interest Expense		Average Cost of Funds			Net Interest Income		Net Interest Rate Spread
(ratios for the quarters have been annualized, dollars in thousands)
Quarter Ended September 30, 2010	$	69,242,085	$	702,976		4.06	%	$	62,034,137	$	302,568		1.95	%	$	400,408		2.11	%
Quarter Ended June 30, 2010	$	61,952,037	$	643,682		4.16	%	$	56,190,308	$	280,242		2.00	%	$	363,440		2.16	%
Quarter Ended March 31, 2010	$	61,983,900	$	654,389		4.22	%	$	55,298,875	$	276,509		2.00	%	$	377,880		2.22	%
Quarter Ended December 31, 2009	$	62,128,320	$	751,663		4.84	%	$	55,919,885	$	286,764		2.05	%	$	464,899		2.79	%
Quarter Ended September 30, 2009	$	60,905,025	$	744,523		4.89	%	$	54,914,435	$	307,777