Edgar Filing: ANNALY CAPITAL MANAGEMENT INC

a50625248.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: MARCH 31, 2013

[ ] 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___

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 __

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

Common Stock, $.01 par value

Outstanding at May 6, 2013

947,368,897

ANNALY CAPITAL MANAGEMENT, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I

		PAGE

Part I. FINANCIAL INFORMATION

	Item 1. Financial Statements:

	Consolidated Statements of Financial Condition at March 31, 2013 (Unaudited) and December 31, 2012 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2012)	1

	Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the quarters ended March 31, 2013 and 2012	2

	Consolidated Statements of Stockholders’ Equity (Unaudited) for the quarters ended March 31, 2013 and 2012	3

	Consolidated Statements of Cash Flows (Unaudited) for the quarters ended March 31, 2013 and 2012	4

	Notes to Consolidated Financial Statements (Unaudited)	6

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

	Item 3. Quantitative and Qualitative Disclosures about Market Risk	43

	Item 4. Controls and Procedures	44

Part II. OTHER INFORMATION

	Item 1. Legal Proceedings	45

	Item 1A. Risk Factors	45

	Item 6. Exhibits	45

	SIGNATURES	48

PART I

Part I

Item 1. Financial Statements

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in thousands, except per share amounts)

ASSETS	March 31, 2013 (Unaudited)			December 31, 2012(1)
Cash and cash equivalents	$	1,862,550		$	615,789
Reverse repurchase agreements		4,933,465			1,811,095
Investments, at fair value:
U.S. Treasury Securities (including pledged assets of $1,645,930 and $752,076, respectively)		1,645,930			752,076
Securities borrowed		2,688,485			2,160,942
Agency mortgage-backed securities (including pledged assets of $98,719,355 and $107,466,084, respectively)		108,256,671			123,963,207
Agency debentures (including pledged assets of $2,707,919 and $981,727, respectively)		3,970,279			3,009,568
Investments in affiliates		267,547			234,120
Corporate debt, held for investment		66,539			63,944
Receivable for investments sold		1,292,478			290,722
Accrued interest and dividends receivable		388,665			419,259
Receivable for advisory and service fees (including from affiliates of $9,244 and $14,077, respectively)		12,817			17,730
Intangible for customer relationships (net of accumulated amortization of $6,037 and $5,779, respectively)		6,731			6,989
Goodwill		55,417			55,417
Other derivative contracts, at fair value		-			9,830
Other assets		54,282			41,607
Total Assets	$	125,501,856		$	133,452,295

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
U.S. Treasury Securities sold, not yet purchased, at fair value	$	611,167		$	495,437
Repurchase agreements		100,322,942			102,785,697
Securities loaned, at fair value		2,330,060			1,808,315
Payable for investments purchased		3,203,461			8,256,957
Payable for share buyback program		-			141,149
Convertible Senior Notes		824,902			825,541
Accrued interest payable		175,749			186,896
Dividends payable		426,173			432,154
Interest rate swaps, at fair value		2,259,173			2,584,907
Accounts payable and other liabilities		37,048			10,798
Other derivative contracts, at fair value		4,812			-
Total Liabilities		110,195,487			117,527,851

Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, issued and outstanding		177,088			177,088
7.625% Series C Cumulative Redeemable Preferred Stock: 12,650,000 authorized, 12,000,000 issued and outstanding		290,514			290,514
7.50% Series D Cumulative Redeemable Preferred Stock: 18,400,000 authorized, issued and outstanding, respectively		445,457			445,457
Common stock, par value $0.01 per share, 1,956,937,500 authorized, 947,293,099 and 947,213,204, issued and outstanding, respectively		9,473			9,472
Additional paid-in capital		14,746,579			14,740,774
Accumulated other comprehensive income (loss)		2,003,248			3,053,242
Accumulated deficit		(2,365,990	)		(2,792,103	)
Total Stockholders’ Equity		15,306,369			15,924,444
Total Liabilities and Stockholders’ Equity	$	125,501,856		$	133,452,295
(1) Derived from the audited consolidated financial statements at December 31, 2012. See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(dollars in thousands, except per share amounts)

(Unaudited)

	For the Quarter Ended March 31,
	2013			2012
Interest income:
Investments	$	728,609		$	850,959
U.S. Treasury Securities		5,996			1,418
Securities loaned		2,612			2,518
Total interest income		737,217			854,895

Interest expense:
Repurchase agreements		157,064			113,914
Convertible Senior Notes		15,813			14,727
U.S. Treasury Securities sold, not yet purchased		2,788			2,644
Securities borrowed		1,925			2,060
Total interest expense		177,590			133,345

Net interest income		559,627			721,550
Other income (loss):
Investment advisory and other fee income		13,540			20,766
Net gains (losses) on disposal of investments		182,843			80,299
Dividend income from affiliates		6,431			7,521
Net gains (losses) on trading assets		1,549			5,256
Net unrealized gains (losses) on interest-only Agency mortgage-backed securities		80,127			30,877
Subtotal		284,490			144,719
Realized gains (losses) on interest rate swaps(1)		(225,476	)		(219,340	)
Realized gains (losses) on termination of interest rate swaps		(16,378	)		(2,385	)
Unrealized gains (losses) on interest rate swaps		325,734			341,639
Subtotal		83,880			119,914
Total other income (loss)		368,370			264,633
Expenses:
Compensation expense		38,443			59,014
Other general and administrative expenses		13,469			8,901
Total expenses		51,912			67,915
Income (loss) before income taxes		876,085			918,268

Income taxes		(5,807	)		(16,462	)

Net income (loss)		870,278			901,806

Dividends on preferred stock		17,992			3,938

Net income (loss) available (related) to common shareholders	$	852,286		$	897,868

Net income (loss) per share available (related) to common shareholders:
Basic	$	0.90		$	0.92
Diluted	$	0.87		$	0.89

Weighted average number of common shares outstanding:
Basic		947,249,901			971,727,701
Diluted		994,815,169			1,010,588,609

Dividends Declared Per Share of Common Stock	$	0.45		$	0.55

Net income (loss)	$	870,278		$	901,806
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities		(867,151	)		(162,259	)
Reclassification adjustment for net (gains) losses included in net income (loss)		(182,843	)		(80,299	)
Other comprehensive income (loss)		(1,049,994	)		(242,558	)
Comprehensive income (loss)	$	(179,716	)	$	659,248

	(1)	Interest expense related to the Company’s interest rate swaps is recorded in Realized gains (losses) on interest rate swaps on the Consolidated Statements of Operations and Comprehensive Income (Loss).
See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(dollars in thousands, except per share amounts)

(Unaudited)

	7.875% Series A Cumulative Redeemable Preferred Stock		7.625% Series C Cumulative Redeemable Preferred Stock		7.50% Series D Cumulative Redeemable Preferred Stock		Common Stock Par Value		Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
BALANCE, DECEMBER 31, 2011	$	177,088		-		-	$	9,702	$	15,068,870		$	3,008,988		$	(2,504,006	)	$	15,760,642
Net income (loss)		-		-		-		-		-			-			901,806			901,806
Unrealized gains (losses) on available-for-sale securities		-		-		-		-		-			(162,259	)		-			(162,259	)
Reclassification adjustment for net (gains) losses included in net income (loss)		-		-		-		-		-			(80,299	)		-			(80,299	)
Exercise of stock options		-		-		-		1		1,841			-			-			1,842
Stock option expense and long-term compensation expense		-		-		-		-		1,849			-			-			1,849
Conversion of Series B cumulative preferred stock		-		-		-		40		32,232			-			-			32,272
Contingent beneficial conversion feature on 4% Convertible Senior Notes		-		-		-		-		23,321			-			-			23,321
Offering expenses		-		-		-		-		(231	)		-			-			(231	)
Preferred Series A dividends declared $0.492 per share		-		-		-		-		-			-			(3,648	)		(3,648	)
Preferred Series B dividends declared $0.375 per share		-		-		-		-		-			-			(289	)		(289	)
Common dividends declared, $0.55 per share		-		-		-		-		-			-			(534,401	)		(534,401	)
BALANCE, MARCH 31, 2012	$	177,088		-		-	$	9,743	$	15,127,882		$	2,766,430		$	(2,140,538	)	$	15,940,605
BALANCE, DECEMBER 31, 2012	$	177,088	$	290,514	$	445,457	$	9,472	$	14,740,774		$	3,053,242		$	(2,792,103	)	$	15,924,444
Net income (loss)		-		-		-		-		-			-			870,278			870,278
Unrealized gains (losses) on available-for-sale securities		-		-		-		-		-			(867,151	)		-			(867,151	)
Reclassification adjustment for net (gains) losses included in net income (loss)		-		-		-		-		-			(182,843	)		-			(182,843	)
Exercise of stock options		-		-		-		-		265			-			-			265
Stock option expense and long-term compensation expense		-		-		-		-		817			-			-			817
Net proceeds from direct purchase and dividend reinvestment		-		-		-		1		760			-			-			761
Contingent beneficial conversion feature on 4% Convertible Senior Notes		-		-		-		-		3,963			-			-			3,963
Preferred Series A dividends declared $0.492 per share		-		-		-		-		-			-			(3,648	)		(3,648	)
Preferred Series C dividends declared $0.477 per share		-		-		-		-		-			-			(5,719	)		(5,719	)
Preferred Series D dividends declared $0.469 per share		-		-		-		-		-			-			(8,625	)		(8,625	)
Common dividends declared, $0.45 per share		-		-		-		-		-			-			(426,173	)		(426,173	)
BALANCE, MARCH 31, 2013	$	177,088	$	290,514	$	445,457	$	9,473	$	14,746,579		$	2,003,248		$	(2,365,990	)	$	15,306,369

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)


	For the Quarters Ended March 31,
	2013			2012
Cash flows from operating activities:
Net income (loss)	$	870,278		$	901,806
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of Investment premiums and discounts, net		421,057			280,336
Amortization of intangibles		323			591
Amortization of deferred expenses		2,038			900
Amortization of contingent beneficial conversion feature on convertible senior notes		3,324			7,828
Net (gains) losses on sales of Agency mortgage-backed securities and debentures		(182,843	)		(80,299	)
Stock option and long-term compensation expense		817			1,849
Unrealized (gains) losses on interest rate swaps		(325,734	)		(341,639	)
Net unrealized (gains) losses on interest-only Agency mortgage-backed securities		(80,127	)		(30,877	)
Net (gains) losses on trading assets		14,829			(2,871	)
Proceeds from repurchase agreements from RCap		237,569,485			127,052,942
Payments on repurchase agreements from RCap		(238,600,415	)		(122,741,955	)
Proceeds from reverse repurchase agreements to RCap		104,959,663			54,896,766
Payments on reverse repurchase agreements to RCap		(108,104,936	)		(56,577,802	)
Proceeds from reverse repurchase agreements to Shannon		376,198			93,892
Payments on reverse repurchase agreements to Shannon		(353,295	)		(92,591	)
Proceeds from securities borrowed		53,799,157			6,683,283
Payments on securities borrowed		(54,326,700	)		(6,877,004	)
Proceeds from securities loaned		110,725,140			32,002,954
Payments on securities loaned		(110,203,395	)		(31,931,006	)
Proceeds from U.S. Treasury Securities		21,683,636			15,808,494
Payments on U.S. Treasury Securities		(22,157,117	)		(14,086,314	)
Net payments on derivatives		(1,490	)		849
Net change in:
Other assets		(14,779	)		(5,918	)
Accrued interest and dividend receivable		22,616			(10,568	)
Advisory and service fees receivable		4,913			(58	)
Accrued interest payable		(11,147	)		(9,857	)
Accounts payable and other liabilities		26,250			50,704
Net cash provided by (used in) operating activities		(3,882,254	)		4,994,435
Cash flows from investing activities:
Payments on purchases of Agency mortgage-backed securities and debentures		(17,699,472	)		(20,099,149	)
Proceeds from sales of Agency mortgage-backed securities and debentures		15,484,409			4,770,341
Principal payments on Agency mortgage-backed securities		8,514,074			7,376,488
Proceeds from Agency debentures called		847,205			151,640
Payments on purchases of corporate debt		(3,483	)		-
Principal payments on corporate debt		911			1,335
Net gains (losses) on other derivative securities		7,465			-
Earn out payment		-			(13,387	)
Net cash provided by (used in) investing activities		7,151,109			(7,812,732	)
Cash flows from financing activities:
Proceeds from repurchase agreements		101,631,583			82,930,109
Principal payments on repurchase agreements		(103,063,408	)		(79,618,116	)
Proceeds from exercise of stock options		265			1,842
Net proceeds from direct purchases and dividend reinvestments		761			-
Net (payments) proceeds from follow-on offerings		-			(231	)
Net payment on share repurchase		(141,149	)		-
Dividends paid		(450,146	)		(556,744	)
Net cash provided by (used in) financing activities		(2,022,094	)		2,756,860
Net (decrease) increase in cash and cash equivalents		1,246,761			(61,437	)
Cash and cash equivalents, beginning of period		615,789			994,198
Cash and cash equivalents, end of period	$	1,862,550		$	932,761

Supplemental disclosure of cash flow information:
Interest received	$	1,188,202		$	1,125,003
Dividends received	$	7,097		$	8,283

Statement continued on following page.

Statement continued from previous page.

Fees received	$	18,453		$	20,708
Interest paid (excluding interest paid on interest rate swaps)	$	184,426		$	134,099
Net interest paid on interest rate swaps	$	226,463		$	220,615
Taxes paid	$	2,382		$	21,401

Noncash investing activities:
Receivable for Investments sold	$	1,292,478		$	454,278
Payable for Investments purchased	$	3,203,461		$	5,708,412
Net change in unrealized loss on available-for-sale securities and interest rate swaps, net of reclassification adjustment	$	(1,049,994	)	$	(242,558	)

Noncash financing activities:
Dividends declared, not yet paid	$	426,173		$	534,401
Conversion of Series B cumulative preferred stock		-		$	32,232
Contingent beneficial conversion feature on Convertible Senior Notes	$	3,963		$	23,321

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 (the “Code”). On June 4, 2004, the Company acquired Fixed Income Discount Advisory Company (“FIDAC”). FIDAC is a registered investment advisor and is a wholly owned taxable REIT subsidiary of the Company. On June 27, 2006, the Company made a majority equity investment in an affiliated investment fund (the “Fund”), which is now wholly owned by the Company. During the third quarter of 2008, the Company formed RCap Securities, Inc. (“RCap”). 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. In 2010, the Company established Shannon Funding LLC (“Shannon”), which provides warehouse financing to residential mortgage originators in the United States. In 2010, the Company also established Charlesfort Capital Management LLC (“Charlesfort”), which engages in corporate middle market lending transactions. In 2011, FIDAC established FIDAC Europe Limited (“FIDAC Europe”), which the Company sold in December 2012. In 2011, the Company established FIDAC FSI LLC (“FIDAC FSI”), which invested in trading securities. FIDAC FSI was liquidated in August 2012. In January 2013, the Company formed CXS Acquisition Corporation (“CXS Acquisition”). CXS Acquisition was formed for the purpose of offering to acquire all of the shares of common stock of CreXus Investment Corp. (“CreXus”) that the Company did not already own.

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

Basis of Accounting

The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP").

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, FIDAC, FIDAC FSI, FIDAC Europe, Merganser, RCap, Shannon, Charlesfort, the Fund and CXS Acquisition. All intercompany balances and transactions have been eliminated in consolidation. Cash flows from RCap are reported as operating activities in the Consolidated Statements of Cash Flows.

Cash and Cash Equivalents - Cash and cash equivalents include cash on hand and cash held in money market funds on an overnight basis. RCap is a member of various clearing organizations with which it maintains cash required for the conduct of its day-to-day clearance activities. Cash and securities deposited with clearing organizations are carried at cost, which approximates fair value, which was $377.8 million and $424.6 million at March 31, 2013 and December 31, 2012, respectively. The Company also maintains collateral in the form of cash on margin with a counterparty to its interest rate swaps of $87.9 million and $102.9 million at March 31, 2013 and December 31, 2012, respectively.

Reverse Repurchase Agreements - RCap enters into reverse repurchase agreements as part of the Company’s matched book trading activity. Reverse repurchase agreements are recorded on trade date at the contract amount and are collateralized by mortgage-backed or other securities. Margin calls are made by the Company as necessary based on the daily valuation of the underlying collateral as compared to the contract price. The Company generates income from the spread between what is earned on the reverse repurchase agreements and what is paid on the matched repurchase agreements. The Company’s policy is to obtain possession of collateral with a market value in excess of the principal amount loaned under reverse repurchase agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is valued daily, and the Company will require counterparties to deposit additional collateral, when necessary. All reverse repurchase activities are transacted under master repurchase agreements that give the Company the right, in the event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty.

Securities borrowed and loaned transactions – RCap records securities borrowed and loaned transactions as collateralized financings. 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 in an amount generally in excess of the fair value of the securities loaned. RCap monitors the fair value of the securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded as necessary. Securities borrowed and securities loaned transactions are recorded at contract value. For these transactions, the rebates accrued by the Company are recorded as interest income or expense.

U.S. Treasury Securities – RCap trades in U.S. Treasury securities for its proprietary portfolio, which consists of long and short positions on U.S Treasury notes and bonds. U.S. Treasury securities are classified as trading investments and are recorded on the trade date at cost. Changes in fair value are reflected in the Company’s Consolidated Statement of Operations and Comprehensive Income (Loss). Generally the Company does not hold the U.S. Treasury notes and bonds to maturity and realizes gains and losses from trading those positions. Interest income or expense on U.S. Treasury notes and bonds is accrued based on the outstanding principal amount of those investments and their stated terms.

Agency 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 Ginnie Mae, Freddie Mac or Fannie Mae (collectively, “Agency mortgage-backed securities”). The Company also invests in Agency debentures issued by Federal Home Loan Bank (“FHLB”), Freddie Mac, and Fannie Mae.

Investment Securities – Agency mortgage-backed securities, Agency debentures, and corporate debt are referred to herein as “Investment Securities.” 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. Investment Securities classified as available-for-sale are reported at fair values estimated by management that are compared to independent sources for reasonableness, with unrealized gains and losses reported as a component of stockholders’ equity. Investment Securities transactions are recorded on the trade date. Realized gains and losses on sales of Investment Securities are determined using the average cost method. The Company’s investments in corporate debt are designated as held for investment, and are carried at their principal balance outstanding plus any premiums or discounts less allowances for loan losses. No allowance for loan losses was deemed necessary as of March 31, 2013 and December 31, 2012.

On April 1, 2011, the Company elected the fair value option for Agency interest-only mortgage-backed securities acquired on or after such date. Interest-only securities and inverse interest-only securities are collectively referred to as “interest-only securities.” These Agency interest-only mortgage-backed securities represent the Company’s right to receive a specified proportion of the contractual interest flows of specific Agency mortgage-backed securities. Agency interest-only mortgage-backed securities acquired on or after April 1, 2011 are measured at fair value through earnings in the Company’s Consolidated Statements of Comprehensive Income. The interest-only securities are included in Agency mortgage-backed securities at fair value on the accompanying Consolidated Statements of Financial Condition.

Interest income from coupon payments 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. Adjustments are made for actual prepayment activity.

Equity Securities – The Company invests in equity securities that are classified as available-for-sale or trading. Equity securities classified as available-for-sale are reported at fair value, based on market quotes, with unrealized gains and losses reported as a component of stockholders’ equity. Equity securities classified as trading are reported at fair value, based on market quotes, with unrealized gains and losses reported in the Consolidated Statements of Operations and Comprehensive Income (Loss). Dividends are recorded in earnings based on the declaration date.

Other-Than-Temporary Impairment – Management evaluates available-for-sale securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. The Company determines if it (1) has the intent to sell the 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 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 Consolidated Statements of Operations and Comprehensive Income (Loss), while the balance of losses related to other factors will be recognized as a component of stockholders’ equity. There was no other-than-temporary impairment for the quarters ended March 31, 2013 and 2012.

Derivative Instruments – The Company accounts for interest rate swaps at fair value as either assets or liabilities on the Consolidated Statements of Financial Condition. Changes in the fair value of interest rate swaps are recognized in earnings. The Company uses interest rate swaps to manage its exposure to changing interest rates on its repurchase agreements. Net payments on interest rate swaps are included in the Consolidated Statements of Cash Flows as a component of operating activities.

The Company elected to net, by counterparty, the fair value of interest rate swap contracts. These contracts contain legally enforceable provisions that allow for netting or setting off swap receivables and payables with each counterparty and, therefore, the fair value of those swap contracts are netted by counterparty. The credit support annex provisions of the Company’s interest rate swap contracts allow the parties to mitigate their credit risk by requiring the party which is out of the money to post collateral. As the Company elects to net by counterparty the fair value of interest rate swap contracts, it also nets by counterparty any collateral exchanged as part of the interest rate swap contracts. Substantially all collateral is non-cash collateral under these contracts. In addition, the Company’s agreements with certain of its counterparties with whom it has both interest rate swap contracts and master repurchase agreements contain legally enforceable provisions that allow for netting or setting off on an aggregate basis all receivables, payables and collateral postings required under both the interest rate swap contract and the master repurchase agreement with respect to each such counterparty.

The Company may from time to time also use a variety of derivative instruments to economically hedge some of its exposure to market risks, including interest rate and prepayment risk. Any such hedging transactions could take a variety of forms, including the use of derivative instruments such as interest rate swap agreements, interest rate swaptions or forward contracts. The Company may also purchase or sell To-Be-Announced (“TBA”) securities, purchase or write put or call options on TBA securities or invest in other types of mortgage derivative securities.

RCap enters primarily into U.S. Treasury, Eurodollar, federal funds, U.S. equity index and currency futures and options contracts. 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 as well as any foreign exchange gains and losses are reflected in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss). Unrealized gains (losses) are excluded from net income (loss) in arriving at cash flows from operating activities in the Consolidated Statements of Cash Flows.

Credit Risk – The Company has limited its exposure to credit losses on its portfolio of Agency 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 Agency mortgage-backed securities are guaranteed by those respective agencies, and the payment of principal and interest on Ginnie Mae Agency 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 Agency mortgage-backed securities and Agency debentures. The Company will have credit risk on commercial loans and securities.

Market Risk - Weakness in the mortgage market may adversely affect the performance and market value of the Company’s investments. This could negatively impact the Company’s 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 Investment Securities 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 Agency 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.

Counterparty Credit Risk – The Company is exposed to risk of loss if an issuer or a counterparty fails to perform its obligations under contractual terms.

The Company has established policies and procedures for mitigating credit risk, including reviewing and establishing limits for credit exposure, limiting transactions with specific counterparties, maintaining qualifying collateral and continually assessing the creditworthiness of counterparties.

Repurchase Agreements - The Company finances the acquisition of a significant portion of its Agency mortgage-backed securities with repurchase agreements. The Company examines each of the specified criteria in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 860, Transfers and Servicing, at the inception of each transaction and has determined that each of the financings meet the specified criteria in this guidance. None of the Company’s repurchase agreements are accounted for as components of linked transactions. As a result, the Company separately accounts for the financial assets and related repurchase financings in the accompanying consolidated financial statements.

Reverse repurchase agreements and repurchase agreements with the same counterparty and the same maturity are presented net in the Consolidated Statements of Financial Condition when the terms of the agreements permit netting. The Company reports cash flows on repurchase agreements as financing activities in the Consolidated Statements of Cash Flows. The Company reports cash flows on repurchase agreements entered into by RCap and Shannon as operating activities in the Consolidated Statements of Cash Flows.

Convertible Senior Notes – The Company records the 4% Convertible Senior Notes and 5% Convertible Senior Notes (collectively, the “Convertible Senior Notes”) at their contractual amounts, adjusted by the effects of a beneficial conversion feature and a contingent beneficial conversion feature (collectively, the “Conversion Features”). This Conversion Features’ intrinsic value is included in “Additional paid-in capital” on the Company’s Consolidated Statements of Financial Condition and reduces the recorded liability amount associated with the Convertible Senior Notes.

The Convertible Senior Notes have a conversion price adjustment feature that is evaluated at the time of the conversion price adjustment. A contingent beneficial conversion feature may be recognized as a result of adjustments to the conversion price for dividends declared. The Company determined the intrinsic value of a contingent beneficial conversion feature on its 4% Convertible Senior Notes.

Income Taxes - The Company has elected to be taxed as a REIT and intends to comply with the provisions of 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 its direct and indirect subsidiaries, FIDAC, Merganser and RCap, have made separate joint elections to treat these 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 their taxable income. FIDAC Europe was located in Europe and was not required to pay United States income taxes. FIDAC Europe was sold by the Company in December 2012.

The provisions of FASB ASC 740, Income Taxes, clarify the accounting for uncertainty in income taxes recognized in financial statements and prescribe a recognition threshold and measurement attribute for tax positions taken or expected to be taken on a tax return. ASC 740 also requires that interest and penalties related to unrecognized tax benefits be recognized in the financial statements. The Company does not have any unrecognized tax benefits that would affect its financial position. Thus, no accruals for penalties and interest were necessary as of March 31, 2013.

Goodwill and Intangible Assets - The Company’s acquisitions of FIDAC and Merganser and FIDAC Europe’s acquisition of certain assets were accounted for using the acquisition method. Under the acquisition method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. 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. In addition, FIDAC Europe acquired a customer relationship after its formation. Goodwill and intangible assets are periodically (but not less frequently than annually) reviewed for potential impairment. Intangible assets with an estimated useful life are amortized over the expected life. During the quarters ended March 31, 2013 and 2012, there were no impairment losses recognized related to goodwill and intangible assets.

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 Company recognizes compensation expense on a straight-line basis over the requisite service period for the entire award.

Use of Estimates - The preparation of the consolidated financial statements in conformity with U.S. 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 trading or 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 to compare to internal prices for reasonableness. Actual results could differ from those estimates.

A Summary of Recent Accounting Pronouncements Follows:

Presentation

Balance Sheet (ASC 210)

On December 23, 2011, FASB released ASU 2011-11 Balance Sheet: Disclosures about Offsetting Assets and Liabilities. Under this update, the Company will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and transactions subject to an agreement similar to a master netting arrangement. The scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements and securities borrowing and securities lending arrangements. This disclosure is intended to enable financial statement users to understand the effect of such arrangements on the Company’s financial position. In January 2013, FASB released ASU 2013-01 Balance Sheet: Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which served solely to clarify the scope of financial instruments included in ASU 2011-11 as there was concern about diversity in practice. The objective of these updates is to support further convergence of US GAAP and IFRS requirements. The updates are effective for annual reporting periods beginning on or after January 1, 2013 and did not have a significant impact on the consolidated financial statements.

Comprehensive Income (ASC 220)

On December 23, 2011, the FASB issued ASU 2011-12, Comprehensive Income: Deferral of Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income In ASU No. 2011-05, which defers those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated OCI. This was done to allow the FASB time to re-deliberate the presentation on the face of the financial statements the effects of reclassifications out of accumulated OCI on the components of net income and OCI. No other requirements under ASU 2011-05 are affected by ASU 2011-12. FASB tentatively decided not to require presentation of reclassification adjustments out of accumulated other comprehensive income on the face of the financial statements and to propose new disclosures instead.

In February 2013, the FASB issued ASU 2013-02 Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This update addresses the disclosure issue left open at the deferral under ASU 2011-12. This update requires the provision of information about the amounts reclassified out of accumulated OCI by component. In addition, it requires presentation, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated OCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, a cross-reference must be provided to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This update is effective for reporting periods beginning after December 15, 2012. Adoption of ASU 2013-02 did not have a significant impact on the consolidated financial statements.

Broad Transactions

Financial Services – Investment Companies (ASC 946)

In October 2011, the FASB issued a proposed ASU 2011-20, Financial Services-Investment Companies: Amendments to the Scope, Measurement, and Disclosure Requirements, which would amend the criteria in ASC 946 for determining whether an entity qualifies as an investment company. As proposed, this ASU would affect the measurement, presentation and disclosure requirements for Investment Companies, as defined, amend the investment company definition in ASC 946, and remove the current exemption for Real Estate Investment Trusts from this topic. If promulgated in its current form, this proposal may result in a material modification to the presentation of the Company’s consolidated financial statements.

On December 12, 2012, the FASB agreed that the accounting for real estate investments should be considered in a second phase of the Investment Companies project and that all REITs should be exempted from conclusions reached in phase I of the project. The FASB has not yet agreed on the scope of phase II of the project.

The Company is monitoring developments related to this proposal and is evaluating the effects it would have on the Company’s consolidated financial statements.

2. AGENCY MORTGAGE-BACKED SECURITIES

The following tables present the Company’s available-for-sale Agency mortgage-backed securities portfolio as of March 31, 2013 and December 31, 2012 which were carried at their fair value:

March 31, 2013	Freddie Mac			Fannie Mae			Ginnie Mae			Total Mortgage- Backed Securities
	(dollars in thousands)

Agency mortgage-backed securities, par value	$	39,115,499		$	61,622,413		$	239,955		$	100,977,867
Unamortized discount		(12,573	)		(13,692	)		(388	)		(26,653	)
Unamortized premium		1,959,152			3,398,430			36,257			5,393,839
Amortized cost		41,062,078			65,007,151			275,824			106,345,053

Gross unrealized gains		818,602			1,516,324			15,965			2,350,891
Gross unrealized losses		(166,212	)		(271,927	)		(1,134	)		(439,273	)

Estimated fair value	$	41,714,468		$	66,251,548		$	290,655		$	108,256,671

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

Adjustable rate	$	4,938,813	$	223,387	$	(2,401	)	$	5,159,799
Fixed rate		101,406,240		2,127,504		(436,872	)		103,096,872

Total	$	106,345,053	$	2,350,891	$	(439,273	)	$	108,256,671

December 31, 2012	Freddie Mac			Fannie Mae			Ginnie Mae			Total Mortgage- Backed Securities
	(dollars in thousands)

Agency mortgage-backed securities, par value	$	44,296,234		$	70,649,782		$	273,988		$	115,220,004
Unamortized discount		(9,515	)		(12,315	)		(389	)		(22,219	)
Unamortized premium		2,121,478			3,695,381			39,348			5,856,207
Amortized cost		46,408,197			74,332,848			312,947			121,053,992

Gross unrealized gains		1,166,299			1,913,334			17,583			3,097,216
Gross unrealized losses		(36,890	)		(146,533	)		(4,578	)		(188,001	)

Estimated fair value	$	47,537,606		$	76,099,649		$	325,952		$	123,963,207

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

Adjustable rate	$	5,786,718	$	259,013	$	(4,613	)	$	6,041,118
Fixed rate		115,267,274		2,838,203		(183,388	)		117,922,089

Total	$	121,053,992	$	3,097,216	$	(188,001	)	$	123,963,207

Actual maturities of Agency mortgage-backed securities are generally shorter than stated contractual maturities because actual maturities of Agency mortgage-backed securities are affected by the contractual lives of the underlying mortgages, periodic payments and prepayments of principal. The following table summarizes the Company’s Agency mortgage-backed securities as of March 31, 2013 and December 31, 2012, according to their estimated weighted-average life classifications:

	March 31, 2013				December 31, 2012

Weighted-Average Life	Fair Value		Amortized Cost		Fair Value		Amortized Cost
	(dollars in thousands)
Less than one year	$	655,460	$	652,987	$	1,264,094	$	1,250,405
Greater than one year through five years		98,984,676		97,021,498		119,288,168		116,510,310
Greater than five years through ten years		8,487,896		8,543,055		3,104,073		2,992,054
Greater than 10 years		128,639		127,513		306,872		301,223
Total	$	108,256,671	$	106,345,053	$	123,963,207	$	121,053,992

The weighted-average lives of the Agency mortgage-backed securities at March 31, 2013 and December 31, 2012 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, volatility, and other factors. The actual weighted average lives of the Agency 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 Agency mortgage-backed securities by length of time that such securities have been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012.

	Unrealized Loss Position For: (dollars in thousands)
	Less than 12 Months							12 Months or More							Total
	Estimated Fair Value		Unrealized Losses			Number of Securities		Estimated Fair Value		Unrealized Losses			Number of Securities		Estimated Fair Value		Unrealized Losses			Number of Securities

March 31, 2013	$	39,235,229	$	(364,700	)		376	$	120,653	$	(74,573	)		31	$	39,355,882	$	(439,273	)		407

December 31, 2012	$	11,220,514	$	(82,721	)		187	$	147,775	$	(105,280	)		39	$	11,368,289	$	(188,001	)		226

The decline in value of these securities is solely due to market conditions and not the quality of the assets. Substantially all of the Agency mortgage-backed securities are “AAA” rated or carry an implied “AAA” rating. The investments are not considered to be 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, and it is not more likely than not that the Company will be required to sell the investments before recovery of the amortized cost bases, which may be maturity. Also, the Company is guaranteed payment of the principal amount of the securities by the respective issuing government agency.

During the quarter ended March 31, 2013, the Company sold $16.3 billion of Agency mortgage-backed securities, resulting in a net realized gain of $182.8 million. During the quarter ended March 31, 2012, the Company sold $5.1 billion of Agency mortgage-backed securities, resulting in a net realized gain of $80.3 million. Average cost is used as the basis on which the realized gain or loss on sale is determined.

Agency interest-only mortgage-backed securities represent the right to receive a specified portion of the contractual interest flows of the underlying unamortized principal balance of specific Agency mortgage-backed securities. As of March 31, 2013, Agency interest-only mortgage-backed securities had net unrealized losses of $64.5 million (consisting of net unrealized losses of $86.5 million included in accumulated deficit and net unrealized gains of $21.9 million included in other comprehensive income) and an amortized cost of $807.1 million.

3. INVESTMENTS IN AFFILIATES, AVAILABLE-FOR-SALE EQUITY SECURITIES

Substantially all of the Company’s available-for-sale equity securities are shares of Chimera Investment Corporation (“Chimera”) and CreXus and are reported at fair value. The Company owned approximately 45.0 million shares of Chimera at a fair value of approximately $143.5 million at March 31, 2013 and approximately 45.0 million shares of Chimera at a fair value of approximately $117.4 million at December 31, 2012. At March 31, 2013 and December 31, 2012, the investment in Chimera had an unrealized gain of $4.6 million and an unrealized loss of $21.5 million, respectively. The Company owned approximately 9.5 million shares of CreXus at a fair value of approximately $124.1 million at March 31, 2013 and approximately 9.5 million shares of CreXus at a fair value of approximately $116.7 million at December 31, 2012. At March 31, 2013 and December 31, 2012, the investment in CreXus had an unrealized loss of $1.4 million and an unrealized loss of $8.7 million, respectively.

The Company has evaluated the near-term prospects of its investment in affiliates in relation to the severity and length of time of the impairment. Based on this evaluation, management has determined that its investment in affiliates is not considered to be other-than-temporarily impaired as of March 31, 2013 and December 31, 2012 as the Company has the intent and ability to retain its investments for a period of time sufficient to allow for any anticipated recovery in market value.

4. GOODWILL

At March 31, 2013 and December 31, 2012 goodwill totaled $55.4 million. Merganser’s prior owners received an additional payment of $13.4 million during the year ended December 31, 2012 relating to earn-out provisions in the merger agreement. This amount was recorded as additional goodwill.

5. FAIR VALUE MEASUREMENTS

The Company follows fair value guidance in accordance with U.S. GAAP to account for its financial instruments. The Company categorizes its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial assets and liabilities recorded at fair value on the Consolidated Statements of Financial Condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques 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.

Agency mortgage-backed securities, Agency debentures and interest rate swaps are valued using quoted prices, including dealer quotes, or internally estimated prices for similar assets. The Company incorporates common market pricing methods, including a spread measurement to the Treasury 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 in its estimates of fair value. Management reviews the fair values generated by the model to determine whether prices are reflective of the current market. Management indirectly corroborates its estimates of the fair value using pricing models by comparing its results to independent prices provided by dealers in the securities and/or third party pricing services. Certain liquid asset classes, such as Agency fixed-rate pass-throughs, may be priced using independent sources such as quoted prices for TBA securities.

The Agency mortgage-backed securities market is considered to be an active market such that participants transact with sufficient frequency and volume to provide transparent pricing information on an ongoing basis. The liquidity of the Agency mortgage-backed securities market and the similarity of the Company’s securities to those actively traded enable the Company to observe quoted prices in the market and utilize those prices as a basis for formulating fair value measurements. Consequently, the Company has classified Agency mortgage-backed securities as Level 2 inputs in the fair value hierarchy.

The fair value of U.S. Treasury securities and investments in affiliates are based on quoted prices in active markets.

	Level 1		Level 2		Level 3
At March 31, 2013	(dollars in thousands)
Assets:
U.S. Treasury Securities	$	1,645,930	$	-		-
Agency mortgage-backed securities		-		108,256,671		-
Agency debentures		-		3,970,279		-
Investment in affiliates		267,547		-		-
Liabilities:
U.S. Treasury Securities sold, not yet purchased		611,167		-		-
Interest rate swaps		-		2,259,173		-
Other derivative contracts		4,812		-		-

	Level 1		Level 2		Level 3
At December 31, 2012	(dollars in thousands)
Assets:
U.S. Treasury Securities	$	752,076	$	-		-
Agency mortgage-backed securities		-		123,963,207		-
Agency debentures		-		3,009,568		-
Investment in affiliates		234,120		-		-
Other derivative contracts		7,955		1,875		-
Liabilities:
U.S. Treasury Securities sold, not yet purchased		495,437		-		-
Interest rate swaps		-		2,584,907		-

The following table summarizes the estimated fair value for all financial assets and liabilities as of March 31, 2013 and December 31, 2012.

		March 31, 2013				December 31, 2012
	Level in Fair Value Hierarchy	Carrying Value		Fair Value		Carrying Value		Fair Value
		(dollars in thousands)
Financial assets:
Cash and cash equivalents(1)	1	$	1,862,550	$	1,862,550	$	615,789	$	615,789
Reverse repurchase agreements(1)	1		4,933,465		4,933,465		1,811,095		1,811,095
U.S. Treasury Securities(2)	1		1,645,930		1,645,930		752,076		752,076
Securities borrowed(2)	2		2,688,485		2,688,485		2,160,942		2,160,942
Agency mortgage-backed securities	2		108,256,671		108,256,671		123,963,207		123,963,207
Agency debentures	2		3,970,279		3,970,279		3,009,568		3,009,568
Investment in affiliates(2)	1		267,547		267,547		234,120		234,120
Corporate debt(3)	2		66,539		67,130		63,944		64,271
Other derivatives(2)	1,2		-		-		9,830		9,830

Financial liabilities:
U.S. Treasury Securities sold, not yet purchased(2)	1	$	611,167	$	611,167	$	495,437	$	495,437
Repurchase agreements(1)(4)	1,2		100,322,942		100,828,852		102,785,697		103,332,832
Securities loaned(2)	2		2,330,060		2,330,060		1,808,315		1,808,315
Convertible Senior Notes(2)	1		824,902		909,255		825,541		899,192
Interest rate swaps	2		2,259,173		2,259,173		2,584,907		2,584,907
Other derivatives(2)	1,2		4,812		4,812		-		-

(1)	Carrying value approximates fair value due to the short-term maturities of these items.

(2)	Fair value is determined using end of day quoted prices in active markets.

(3)

The carrying value of the corporate debt is based on amortized cost. Estimates of fair value of corporate debt require the use of significant judgments and inputs including, but not limited to, the enterprise value of the borrower (i.e., an estimate of the total fair value of the borrower's debt and equity), the nature and realizable value of any collateral, the borrower’s ability to make payments when due and its earnings history. Management also considers factors that affect the macro and local economic markets in which the borrower operates.

(4)	The fair value of repurchase agreements with maturities greater than one year are valued as pay fixed versus receive floating interest rate swaps.

6. REPURCHASE AGREEMENTS

The Company had outstanding $100.3 billion and $102.8 billion of repurchase agreements with weighted average borrowing rates of 1.49% and 1.53%, after giving effect to the Company’s interest rate swaps, and weighted average remaining maturities of 198 days and 191 days as of March 31, 2013 and December 31, 2012, respectively. Investment Securities and U.S. Treasury securities pledged as collateral under these repurchase agreements and interest rate swaps had an estimated fair value and accrued interest of $103.1 billion and $328.2 million at March 31, 2013, respectively, and $109.2 billion and $363.8 million at December 31, 2012, respectively.

At March 31, 2013 and December 31, 2012, the repurchase agreements had the following remaining maturities and weighted average rates:

	March 31, 2013					December 31, 2012
	Repurchase Agreements		Weighted Average Rate			Repurchase Agreements		Weighted Average Rate
	(dollars in thousands)
1 day	$	6,664,087		0.32	%	$	-		-
2 to 29 days		26,451,593		0.46	%		33,191,448		0.50	%
30 to 59 days		13,129,666		0.44	%		28,383,851		0.45	%
60 to 89 days		8,705,572		0.36	%		8,602,680		0.42	%
90 to 119 days		11,103,023		0.47	%		4,804,671		0.57	%
Over 120 days		34,269,001		0.91	%		27,803,047		1.03	%
Total	$	100,322,942		0.59	%	$	102,785,697		0.63	%

Repurchase agreements and reverse repurchase agreements with the same counterparty and the same maturity are presented net in the Consolidated Statements of Financial Condition when the terms of the agreements permit netting. The following table summarizes gross amounts of repurchase agreements and reverse repurchase agreements, amounts offset in accordance with netting arrangements and net amounts of repurchase agreements and reverse repurchase agreements as presented in the Consolidated Statements of Financial Condition as of March 31, 2013 and December 31, 2012.

	March 31, 2013						December 31, 2012
	Reverse Repurchase Agreements			Repurchase Agreements			Reverse Repurchase Agreements			Repurchase Agreements
	(dollars in thousands)

Gross Amounts	$	7,041,379		$	102,430,856		$	3,650,053		$	104,624,655
Amounts Offset		(2,107,914	)		(2,107,914	)		(1,838,958	)		(1,838,958	)
Netted Amounts	$	4,933,465		$	100,322,942		$	1,811,095		$	102,785,697

7. 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 March 31, 2013, such instruments are comprised of interest rate swaps, which in effect modify the cash flows on repurchase agreements, or convert floating rate liabilities to fixed rates. The purpose of the swaps is to mitigate the risk of rising interest rates that affect the Company’s cost of funds. 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 Investment Securities pledged as collateral for swaps. The Company’s interest rate swaps have not been designated as hedging instruments for accounting purposes.

	March 31, 2013
	Interest Rate Swaps - Asset						Interest Rate Swaps - Liability
	Notional			Unrealized Gains			Notional		Unrealized Losses
	(dollars in thousands)

Gross Amounts	$	1,910,000		$	46,612		$	46,312,800	$	2,305,785
Amounts Offset		(1,910,000	)		(46,612	)		1,910,000		(46,612	)
Netted Amounts		-			-		$	48,222,800	$	2,259,173


	December 31, 2012
	Interest Rate Swaps - Asset						Interest Rate Swaps - Liability
	Notional			Unrealized Gains			Notional		Unrealized Losses
	(dollars in thousands)

Gross Amounts	$	1,100,000		$	26,020		$	45,811,800	$	2,610,927
Amounts Offset		(1,100,000	)		(26,020	)		1,100,000		(26,020	)
Netted Amounts		-			-		$	46,911,800	$	2,584,907

The effect of interest rate swaps on the Consolidated Statements of Comprehensive Income (Loss) is as follows:

	Location on Consolidated Statements of Operations and Comprehensive Income (Loss)
	Realized Gains (Losses) on Interest Rate Swaps(1)			Realized Gains (Losses) on Termination of Interest Rate Swaps			Unrealized Gains (Losses) on Interest Rate Swaps
	(dollars in thousands)
For the Quarter Ended March 31, 2013	$	(225,476	)	$	(16,378	)	$	325,734
For the Quarter Ended March 31, 2012	$	(219,340	)	$	(2,385	)	$	341,639

(1) Net interest payments on interest rate swaps is presented in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss) as realized gains (losses) on interest rate swaps.

The Company’s interest rate swap weighted average pay rate at March 31, 2013 was 2.08% and the weighted average receive rate was 0.23%. The weighted average pay rate at December 31, 2012 was 2.21% and the weighted average receive rate was 0.24%.

Certain of the Company’s derivative contracts are subject to International Swaps and Derivatives Association Master Agreements (“ISDA”) which contain provisions that grant counterparties certain rights with respect to the applicable ISDA upon the occurrence of (i) negative performance that results in a decline in net assets in excess of specified thresholds or dollar amounts over set periods of time, (ii) the Company’s failure to maintain its REIT status, (iii) the Company’s failure to comply with limits on the amount of leverage, and (iv) the Company’s stock being delisted from the New York Stock Exchange (NYSE). Upon the occurrence of items (i) through (iv), the counterparty to the applicable ISDA has a right to terminate the ISDA in accordance with its provisions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position at March 31, 2013 is approximately $2.3 billion, including accrued interest, which represents the maximum amount the Company would be required to pay upon termination. This amount is fully collateralized.

In connection with RCap’s proprietary trading activities, it enters primarily into U.S. Treasury, Eurodollar, federal funds, German government and U.S. equity index futures and options contracts. 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 uses an appropriately licensed futures commission merchant and options broker dealer to execute its orders to buy and sell futures and options contracts. RCap’s derivative contracts are presented in the Consolidated Statements of Financial Condition as Other derivatives.

8. CONVERTIBLE SENIOR NOTES

In 2010, the Company issued $600.0 million in aggregate principal amount of its 4% convertible senior notes due 2015 (“4% Convertible Senior Notes”) for net proceeds of approximately $582.0 million. Interest on the 4% Convertible Senior Notes is paid semi-annually at a rate of 4% per year and the 4% Convertible Senior Notes will mature on February 15, 2015 unless repurchased or converted earlier. The 4% Convertible Senior Notes are convertible into shares of Common Stock at a conversion rate for each $1,000 principal amount of 4% Convertible Senior Notes. The initial conversion rate was 46.6070, which was equivalent to an initial conversion price of approximately $21.4560 per share of Common Stock. The conversion rate at March 31, 2013 was 72.7592, which is equivalent to a conversion price of approximately $13.7440 per share of Common Stock. The conversion rate is subject to adjustment in certain circumstances. There is no limit on the total number of shares of Common Stock that the Company would be required to issue upon a conversion.

The intrinsic value of the contingent beneficial conversion feature was $79.8 million and $75.8 million at March 31, 2013 and December 31, 2012, respectively, which is reflected in Additional paid-in capital on the Company’s Consolidated Statements of Financial Condition, and reduces the recorded liability on the 4% Convertible Senior Notes. The unamortized contingent beneficial conversion feature of the 4% Convertible Senior Notes at March 31, 2013 and December 31, 2012 of $24.3 million and $22.7 million, respectively, is recognized in interest expense over the remaining life of the notes.

In May 2012, the Company issued $750.0 million in aggregate principal amount of its 5% convertible senior notes due 2015 (“5% Convertible Senior Notes”) for net proceeds of approximately $727.5 million. Interest on the 5% Convertible Senior Notes is paid semi-annually at a rate of 5% per year and the 5% Convertible Senior Notes will mature on May 15, 2015 unless repurchased or converted earlier. The 5% Convertible Senior Notes are convertible into shares of Common Stock at a conversion rate for each $1,000 principal amount of 5% Convertible Senior Notes. The initial conversion rate and conversion rate at March 31, 2013 was 52.7969, which was equivalent to an initial conversion price of approximately $18.94 per share of Common Stock, subject to adjustment in certain circumstances. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of Common Stock or a combination of cash and shares of Common Stock, at the Company’s sole discretion. There is no limit on the total number of shares of Common Stock that the Company would be required to issue upon a conversion.

At issuance, the Company determined that the 5% Convertible Senior Notes included an equity component of $11.7 million, which is reflected in Additional paid-in capital on the Company’s Consolidated Statements of Financial Condition, and reduces the recorded liability on the 5% Convertible Senior Notes. The $11.7 million discount to the principal amount of the Convertible Senior Notes is recognized in interest expense over the remaining life of the notes. At March 31, 2013, $8.3 million of the discount had not been reflected in interest expense.

The 4% Convertible Senior Notes due 2015 and the 5% Convertible Senior Notes due 2015 rank pari passu with each other. They are each general corporate obligations and therefore rank junior to collateralized debt of the company with respect to secured collateral.

The 4% Convertible Senior Notes and the 5% Convertible Senior Notes rank senior to the 7.875% Series A Cumulative Redeemable Preferred Stock, 7.625% Series C Cumulative Redeemable Preferred Stock and 7.50% Series D Cumulative Redeemable Preferred Stock. The 7.875% Series A Cumulative Redeemable Preferred Stock, 7.625% Series C Cumulative Redeemable Preferred Stock and 7.50% Series D Cumulative Redeemable Preferred Stock rank pari passu with each other.

The 7.875% Series A Cumulative Redeemable Preferred Stock, 7.625% Series C Cumulative Redeemable Preferred Stock and 7.50% Series D Cumulative Redeemable Preferred Stock rank senior to the common stock of the Company.

9. COMMON STOCK AND PREFERRED STOCK

(A) Common Stock

During the quarter ended March 31, 2013, 20,000 options were exercised for an aggregate exercise price of $265,000. During the quarter ended March 31, 2012, 126,000 options were exercised for an aggregate exercise price of $1.8 million, respectively.

During the quarter ended March 31, 2013, the Company raised $761,000, by issuing 50,000 shares through the Direct Purchase and Dividend Reinvestment Program. During the quarter ended March 31, 2012, the Company did not raise proceeds through the Direct Purchase and Dividend Reinvestment Program.

During the quarter ended March 31, 2012, 1.3 million shares of 6.00% Series B Cumulative Convertible Preferred Stock (“Series C Preferred Stock”) were converted into 4.0 million shares of common stock.

On March 19, 2012, the Company entered into six separate Distribution Agency Agreements (“Distribution Agency Agreements”) with each of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse Securities (USA) LLC, Goldman, Sachs & Co., J.P. Morgan Securities LLC, Morgan Stanley & Co. LLC and RCap Securities, Inc. (together, the Agents). Pursuant to the terms of the Distribution Agency Agreements, the Company may sell from time to time through the Agents, as its sales agents, up to 125,000,000 shares of the Company’s common stock. The Company did not make any sales under the Distribution Agency Agreements during the quarters ended March 31, 2013 and 2012.

On October 16, 2012, the Company announced that its Board of Directors has authorized the repurchase of up to $1.5 billion of its outstanding common shares over a 12 month period. All common shares purchased are part of a publicly announced plan in open-market transactions. During the year ended December 31, 2012, the Company repurchased approximately 27.8 million shares of its outstanding common stock for $397.1 million, of which $141.1 million had not settled at December 31, 2012. During the quarter ended March 31, 2013, the Company did not repurchase any shares of its outstanding common stock.

On May 16, 2012, the Company amended its charter through the filing of articles supplementary to its charter to reclassify 12,650,000 shares of authorized shares of Common Stock as 7.625% Series C Cumulative Redeemable Preferred Stock (“Series C Preferred Stock”).

In May 2012, the Company issued 12,000,000 shares of Series C Preferred Stock, with a par value of $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared).

On September 13, 2012, the Company amended its charter through the filing of articles supplementary to its charter to reclassify 18,400,000 shares of authorized shares of Common Stock as 7.50% Series D Cumulative Redeemable Preferred Stock (“Series D Preferred Stock”).

In September 2012, the Company issued 18,400,000 shares of Series D Preferred Stock, with a par value of $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared).

Following the effectiveness of the articles supplementary to its charter the Company’s authorized shares of capital stock, par value of $0.01 per share, consists of 1,956,937,500 shares classified as Common Stock, 7,412,500 shares classified as 7.875% Series A Cumulative Redeemable Preferred Stock, 4,600,000 shares classified as 6.00% Series B Cumulative Convertible Preferred Stock, 12,650,000 shares classified as 7.625% Series C Cumulative Redeemable Preferred Stock and 18,400,000 shares classified as 7.50% Series D Cumulative Redeemable Preferred Stock.

(B) Preferred Stock

At March 31, 2013 and December 31, 2012, 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 is entitled to a dividend at a rate of 7.875% per year based 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 C Preferred Stock and Series D 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 C Preferred Stock and Series D 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 restricted 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, Series C Preferred Stock and Series D Preferred Stock. Through March 31, 2013, the Company had declared and paid all required quarterly dividends on the Series A Preferred Stock.

At March 31, 2013 and December 31, 2012, the Company had issued and outstanding 12,000,000 shares of Series C Preferred Stock, with a par value of $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series C Preferred Stock is entitled to a dividend at a rate of 7.625% per year based on the $25.00 liquidation preference before the common stock is entitled to receive any dividends. The Series C 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 May 16, 2017 (subject to the Company’s right under limited circumstances to redeem the Series C Preferred Stock earlier in order to preserve its qualification as a REIT or under limited circumstances related to a change of control of the Company). The Series C Preferred Stock is senior to the Company’s common stock and is on parity with the Series A Preferred Stock and Series D Preferred Stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series C Preferred Stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series C Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series C Preferred Stock, together with the Series A Preferred Stock and Series D 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 restricted for payment. In addition, certain material and adverse changes to the terms of the Series C Preferred Stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series C Preferred Stock and Series A Preferred Stock and Series D Preferred Stock. Through March 31, 2013, the Company had declared and paid all required quarterly dividends on the Series C Preferred Stock.

At March 31, 2013 and December 31, 2012, the Company had issued and outstanding 18,400,000 shares of Series D Preferred Stock, with a par value of $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series D Preferred Stock is entitled to a dividend at a rate of 7.50% per year based on the $25.00 liquidation preference before the common stock is entitled to receive any dividends. The Series D 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 September 13, 2017 (subject to the Company’s right under limited circumstances to redeem the Series D Preferred Stock earlier in order to preserve its qualification as a REIT or under limited circumstances related to a change of control of the Company). The Series D Preferred Stock is senior to the Company’s common stock and is on parity with the Series A Preferred Stock and Series C Preferred Stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series D Preferred Stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series D Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series D Preferred Stock, together with the Series A Preferred Stock and Series C 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 restricted for payment. In addition, certain material and adverse changes to the terms of the Series D Preferred Stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series D Preferred Stock. Through March 31, 2013, the Company had declared and paid all required quarterly dividends on the Series D Preferred Stock.

During the quarter ended March 31, 2013, the Company declared dividends to common shareholders totaling $426.2 million or $0.45 per share, which were paid to shareholders on April 29, 2013. During the quarter ended March 31, 2013, the Company declared dividends to Series A Preferred Stock shareholders totaling approximately $3.6 million or $0.492 per share, Series C Preferred Stock shareholders totaling approximately $5.7 million or $0.477 per share and Series D Preferred Stock shareholders totaling approximately $8.6 million or $0.469, per share which were paid to preferred shareholders on April 1, 2013.

During the quarter ended March 31, 2012, the Company declared dividends to common shareholders totaling $534.4 million or $0.55 per share, which were paid to shareholders on April 26, 2012. During the quarter ended March 31, 2012, the Company declared dividends to Series A Preferred Stock shareholders totaling approximately $3.6 million or $0.492 per share, and Series B Preferred Stock shareholders totaling approximately $289,000 or $0.375 per share, which were paid to preferred shareholders on April 2, 2012.

10. 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 ended March 31, 2013 and 2012.

	For the Quarter Ended
	March 31, 2013		March 31, 2012
Net income (loss)	$	870,278	$	901,806
Less: Preferred stock dividends		17,992		3,938
Net income (loss) available to common shareholders, prior to adjustment for dilutive potential common shares, if necessary		852,286		897,868
Add: Interest on Convertible Senior Notes, if dilutive		10,450		6,000
Net income (loss) available to common shareholders, as adjusted	$	862,736	$	903,868
Weighted average shares of common stock outstanding-basic		947,250		971,728
Add: Effect of dilutive stock options and Convertible Senior Notes, if dilutive		47,565		38,861
Weighted average shares of common stock outstanding-diluted		994,815		1,010,589

Options to purchase 3.4 million shares of common stock were outstanding and considered anti-dilutive as their exercise price and associated option expense exceeded the average stock price for the quarter ended March 31, 2013. Options to purchase 2.8 million shares of common stock were outstanding and considered anti-dilutive as their exercise price and option expense exceeded the average stock price for the quarter ended March 31, 2012.

11. LONG-TERM STOCK INCENTIVE PLANS

The Company has adopted the 2010 Equity Incentive Plan, which authorizes the Compensation Committee of the board of directors to grant options, stock appreciation rights, dividend equivalent rights, or other share-based awards, including restricted shares up to an aggregate of 25,000,000 shares, subject to adjustments as provided in the 2010 Equity Incentive Plan. The Company had adopted a long term stock incentive plan for executive officers, key employees and non-employee directors (the Prior Plan). The Prior 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 Prior 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 a ceiling of 8,932,921 shares. No further awards will be made under the Prior Plan, although existing awards remain effective.

Stock options were issued at the 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 Company has issued and outstanding the following stock options as of March 31, 2013 and 2012:

	For the Quarter Ended
	March 31, 2013					March 31, 2012
	Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price
Options outstanding at the beginning of period		5,618,686		$	15.74		6,216,805		$	15.57
Granted		-			-		-			-
Exercised		(20,000	)		13.25		(126,394	)		14.57
Forfeited		(943,975	)		16.57		-			-
Expired		-			-		-			-
Options outstanding at the end of period		4,654,711		$	15.58		6,090,411		$	15.59
Options exercisable at the end of the period		4,049,149		$	15.93		4,325,299		$	16.22

The weighted average remaining contractual term was approximately 4.3 years for stock options outstanding and approximately 4.0 years for stock options exercisable as of March 31, 2013. As of March 31, 2013, there was no unrecognized compensation cost related to nonvested share-based compensation awards.

The weighted average remaining contractual term was approximately 5.2 years for stock options outstanding and approximately 4.5 years for stock options exercisable as of March 31, 2012. As of March 31, 2012, there was approximately $3.1 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 1 year.

12. INCOME TAXES

For the period ended March 31, 2013 the Company is qualified to be taxed as a REIT. As a REIT, the Company is not subject to federal income tax to the extent that it distributes its taxable income to its shareholders. To maintain qualification as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to its shareholders and meet certain other requirements. It is generally the Company’s policy to distribute to its shareholders all of the Company’s taxable income except for the amount of taxable income attributable to certain employee remuneration deductions disallowed for tax purposes pursuant to Internal Revenue Code Section 162(m). Accordingly, in general, the Company is subject to federal, state and local income taxes on taxable income attributable to the Section 162(m) disallowance. It is assumed that the Company intends to retain its REIT status by complying with the REIT regulations and its distribution policy in the future. The state and city tax jurisdictions for which the Company is subject to tax filing obligations recognized the Company’s status as a REIT.

During the quarter ended March 31, 2013, the Company’s taxable REIT subsidiaries recorded $1.9 million 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 ended March 31, 2013, the Company recorded $3.9 million of income tax expense for a portion of earnings retained based on Section 162(m) limitations.

During the quarter ended March 31, 2012, the Company’s taxable REIT subsidiaries recorded $1.8 million 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 ended March 31, 2012, the Company recorded $14.7 million of income tax expense for a portion of earnings retained based on Section 162(m) limitations.

The Company’s effective tax rate differs from its combined federal, state, and city corporate statutory tax rate primarily due to the deduction of dividend distributions and Sec 162(m) limitations.

The Company’s 2009, 2010 and 2011 federal and state tax returns remain open for examination.

13. LEASE COMMITMENTS AND CONTINGENCIES

Commitments

The Company has a non-cancelable lease for office space which commenced in May 2002 and expires in December 2014. 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 lease expense for the quarters ended March 31, 2013 and 2012 were $632,000 and $621,000, respectively. The Company’s aggregate future minimum lease payments total $4.9 million. The following table details the lease payments.

Year Ending December	Lease Commitment		Sublease Income		Net Amount
	(dollars in thousands)
2013 (remaining)		$2,203		$15		$2,188
2014		2,509		-		2,509
2015		159		-		159
2016		26		-		26
Later years		-		-		-
		$4,897		$15		$4,882

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 March 31, 2013 and December 31, 2012.

14. 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 Interest Earning Assets 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.

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 Interest Earning Assets by entering into interest rate agreements such as interest rate caps and interest rate swaps. As of March 31, 2013 and December 31, 2012, 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 $48.2 billion and $46.9 billion, respectively.

Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on Agency 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 Agency 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.

15. 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 required to maintain minimum net capital by the Financial Industry Regulatory Authority (“FINRA”). As of March 31, 2013 RCap had a minimum net capital requirement of $273,726. 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 March 31, 2013 was $295.5 million with excess net capital of $295.2 million.

16. RELATED PARTY TRANSACTIONS

For the quarters ended March 31, 2013 and 2012 the Company recorded advisory fees from Chimera and CreXus totaling $9.3 million and $16.4 million, respectively. At March 31, 2013 and December 31, 2012, the Company had amounts receivable from Chimera and CreXus of $9.2 million and $14.1 million, respectively.

17. SUBSEQUENT EVENTS

On April 17, 2013, the Company, through its wholly owned subsidiary CXS Acquisition purchased approximately 55.1 million shares of CreXus, at a purchase price of $13.05206 per share for an aggregate cost of approximately $718.7 million. The purchased shares increased Annaly’s direct and indirect ownership to approximately 84.3% of CreXus’ common stock. CXS Acquisition exercised its option to purchase, at a purchase price of $13.05206 per share, the number of newly-issued shares of CreXus common stock necessary for CXS Acquisition to own one share more than 90% of the outstanding CreXus shares. CXS Acquisition will be merged with and into CreXus in a transaction in which each share of CreXus common stock that was not tendered, except shares owned by the Company or CXS Acquisition, will be converted into the right to receive $13.05206, in cash, subject to any required withholding taxes. The Company intends to complete the merger with CreXus on May 23, 2013.

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, our ability to integrate the commercial mortgage business, our ability to consummate any contemplated investment opportunities and other corporate transactions, changes in governmental regulations affecting our business, our ability to maintain our classification as a REIT for federal income tax purposes, our ability to maintain our exemption from registration under the Investment Company Act of 1940, and risks associated with the business of our subsidiaries, including the investment advisory businesses 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.

All references to “we,” “us,” or “our” mean Annaly Capital Management, Inc. and all entities owned by us, except where it is made clear that the term means only the parent company. The following defines certain of the commonly used terms in this quarterly report on Form 10-Q: Agency refers to a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae; Agency mortgage-backed securities refers to residential mortgage-backed securities that are issued or guaranteed by an Agency; Investment Securities refers to Agency mortgage-backed securities, Agency debentures, corporate debt securities and reverse repurchase agreement loans; and Interest Earning Assets refers to Investment Securities, securities borrowed and U.S. Treasury Securities.

Overview

We own, manage and finance a portfolio of real estate related investments, 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 our Investment Securities and from dividends we receive from our subsidiaries. Our wholly-owned subsidiaries offer diversified real estate, asset management and other financial services. While we remain committed to the Agency market, given the current environment, we believe it is prudent to diversify a portion of our investment portfolio. Therefore, we may allocate up to 25% of our stockholders’ equity to real estate assets other than Agency mortgage-backed securities.

We are a Maryland corporation that commenced operations on February 18, 1997. We are self-advised and self-managed. We acquired Fixed Income Discount Advisory Company (or FIDAC) on June 4, 2004 and Merganser Capital Management, Inc. (or Merganser) on October 31, 2008. FIDAC and Merganser manage a number of investment vehicles and separate accounts for which they earn fee income. Our subsidiary, RCap Securities, Inc. (or RCap), operates as a broker-dealer, and was granted membership in the Financial Industry Regulatory Authority (or FINRA) in January 2009. In 2010, we established Shannon Funding LLC (or Shannon), which provides warehouse financing to residential mortgage originators in the United States. In 2010, we also established Charlesfort Capital Management LLC (or Charlesfort), which engages in corporate middle market lending transactions. We also own an additional subsidiary which owns trading securities. In January 2013, we formed CXS Acquisition Corporation (or CXS Acqui