Edgar Filing: ANNALY CAPITAL MANAGEMENT INC

a50057968.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2011

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

EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER: 1-13447

ANNALY CAPITAL MANAGEMENT, INC.

(Exact name of Registrant as specified in its Charter)

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

1211 AVENUE OF THE AMERICAS, SUITE 2902

NEW YORK, NEW YORK

(Address of principal executive offices)

10036

(Zip Code)

(212) 696-0100

(Registrant’s telephone number, including area code)

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

Yes x No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

	Class	Outstanding at November 8, 2011
	Common Stock, $.01 par value	970,083,961

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 September 30, 2011 (Unaudited) and December 31, 2010 (Derived from the audited Consolidated Statement of Financial Condition at December 31, 2010)	1

Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the quarters and nine months ended September 30, 2011 and 2010	2

Consolidated Statements of Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2011 and 2010	4

Consolidated Statements of Cash Flows (Unaudited) for the quarters and nine months ended September 30, 2011 and 2010	5

Notes to Consolidated Financial Statements (Unaudited)	7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3. Quantitative and Qualitative Disclosures about Market Risk	39

Item 4. Controls and Procedures	40

Part II. OTHER INFORMATION

Item 1. Legal Proceedings	42

Item 1A. Risk Factors	42

Item 6. Exhibits	42

SIGNATURES	45

PART I

Part I

Item 1. Financial Statements

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in thousands, except share and per share amounts)

ASSETS	September 30, 2011 (Unaudited)			December 31, 2010(1)
Cash and cash equivalents	$	3,473,866		$	282,626
Reverse repurchase agreements		360,315			1,006,163
Investments, at fair value:
U.S. Treasury Securities (including pledged assets of $158,556 and $660,823, respectively)		172,892			1,100,447
Securities borrowed		1,052,810			216,676
Agency Mortgage-Backed Securities (including pledged assets of $92,974,164 and $67,787,023, respectively)		106,588,710			78,440,330
Agency debentures (including pledged assets of $488,063 and $1,068,869, respectively)		824,092			1,108,261
Investments in affiliates		209,374			252,863
Equity securities		3,929			-
Corporate debt, held for investment		27,988			21,683
Receivable for investments sold		402,817			151,460
Accrued interest and dividends receivable		410,862			345,250
Receivable from Prime Broker		3,272			3,272
Receivable for advisory and service fees		19,656			16,172
Intangible for customer relationships, net		11,531			9,290
Goodwill		42,030			42,030
Interest rate swaps, at fair value		-			2,561
Other derivative contracts, at fair value		1,450			2,607
Other assets		26,112			24,899
Total assets	$	113,631,706		$	83,026,590
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
U.S. Treasury Securities sold, not yet purchased, at fair value	$	549,505		$	909,462
Repurchase agreements		86,495,905			65,533,537
Securities loaned, at fair value		907,061			217,841
Payable for investments purchased		5,852,986			4,575,026
Convertible Senior Notes		557,045			600,000
Accrued interest payable		128,371			115,766
Dividends payable		581,752			404,220
Interest rate swaps, at fair value		2,540,558			754,439
Other derivative contracts, at fair value		-			2,446
Accounts payable and other liabilities		74,837			8,921
Total liabilities		97,688,020			73,121,658

6.00% Series B Cumulative Convertible Preferred Stock: 4,600,000 shares authorized, 1,389,249 and 1,652,047 shares issued and outstanding, respectively		33,664			40,032

Stockholders’ Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,412,500 authorized, issued and outstanding		177,088			177,088
Common stock, par value $0.01 per share, 1,987,987,500 authorized, 969,913,060 and 631,594,205 issued and outstanding, respectively		9,699			6,316
Additional paid-in capital		15,042,361			9,175,245
Accumulated other comprehensive income (loss)		3,073,488			1,164,642
Accumulated deficit		(2,392,614	)		(658,391	)
Total stockholders’ equity		15,910,022			9,864,900

Total liabilities, Series B Cumulative Convertible Preferred Stock and stockholders’ equity	$	113,631,706		$	83,026,590

(1)	Derived from the audited consolidated financial statements at December 31, 2010.

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(dollars in thousands, except share and per share amounts)

(Unaudited)

	For the Quarters Ended September 30,						For the Nine Months Ended September 30,
	2011			2010			2011			2010
Interest income:
Investments	$	926,558		$	700,964		$	2,713,141		$	1,997,681
U.S. Treasury Securities		2,302			751			13,624			791
Securities loaned		1,942			1,261			5,153			2,575
Total interest income		930,802			702,976			2,731,918			2,001,047

Interest expense:
Repurchase agreements		109,014			105,393			311,780			294,457
Convertible Senior Notes		8,798			7,033			22,465			17,194
U.S. Treasury Securities sold, not yet purchased		2,109			459			11,867			483
Securities borrowed		1,496			1,047			4,081			2,176
Total interest expense		121,417			113,932			350,193			314,310

Net interest income		809,385			589,044			2,381,725			1,686,737

Other income (loss):
Investment advisory and other fee income		20,828			15,343			58,745			41,752
Net gains (losses) on sales of Agency mortgage-backed securities and debentures		91,668			61,986			126,189			147,989
Dividend income		8,706			8,097			23,233			23,391
Net gains (losses) on trading assets		1,942			1,082			15,042			1,159
Net unrealized gain (losses) on interest-only Agency mortgage-backed securities		(39,321	)		-			(39,045	)		-
Income (expense) from underwriting		2,772			915			5,599			1,415
Subtotal		86,595			87,423			189,763			215,706
Realized gains (losses) on interest rate swaps(1)		(231,849	)		(188,636	)		(654,757	)		(545,009	)
Unrealized gains (losses) on interest rate swaps		(1,505,333	)		(448,253	)		(1,802,968	)		(1,158,023	)
Subtotal		(1,737,182	)		(636,889	)		(2,457,725	)		(1,703,032	)
Total other income (loss)		(1,650,587	)		(549,466	)		(2,267,962	)		(1,487,326	)
Expenses:
Distribution fees		-			-			-			360
General and administrative expenses		65,194			43,430			174,250			124,991
Total expenses		65,194			43,430			174,250			125,351

Income (loss) before income taxes and income from equity method investment in affiliate		(906,396	)		(3,852	)		(60,487	)		74,060

Income taxes		(15,417	)		(11,076	)		(41,754	)		(27,227	)

Income from equity method investment in affiliate		-			868			1,140			1,943

Net income (loss)		(921,813	)		(14,060	)		(101,101	)		48,776

Dividends on preferred stock		4,172			4,515			12,706			13,765

Net income (loss) available (related) to common shareholders	$	(925,985	)	$	(18,575	)	$	(113,807	)	$	35,011

Net income (loss) available (related) per share to common shareholders:
Basic	$	(0.98	)	$	(0.03	)	$	(0.14	)	$	0.06
Diluted	$	(0.98	)	$	(0.03	)	$	(0.14	)	$	0.06

Weighted average number of common shares outstanding:
Basic		948,545,975			611,904,518			841,912,810			575,742,043
Diluted		948,545,975			611,904,518			841,912,810			575,958,563

Net income (loss)	$	(921,813	)	$	(14,060	)	$	(101,101	)		48,776
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale securities		1,115,325			(619,080	)		2,020,737			52,880
Unrealized losses on interest rate swaps		-			18,402			14,298			81,329
Reclassification adjustment for net (gains) losses included in net income (loss)		(91,668	)		(61,986	)		(126,189	)		(147,989	)
Other comprehensive income (loss)		1,023,657			(662,664	)		1,908,846			(13,780	)
Comprehensive income (loss)	$	101,844		$	(676,724	)	$	1,807,745		$	34,996

(1) Interest expense related to the Company’s interest rate swaps is recorded in Realized 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 data)

(Unaudited)

	Preferred Stock		Common Stock Par Value		Additional Paid-In Capital		Accumulated Other Comprehensive Income			Accumulated Deficit			Total

BALANCE, December 31, 2009	$	177,088	$	5,531	$	7,817,454	$	1,891,317		$	(336,964	)	$	9,554,426

Net income		-		-		-		-			48,776			48,776
Other comprehensive income		-		-		-		(13,780	)		-			(13,780	)
Net proceeds from follow-on offering		-		600		1,046,793		-			-			1,047,393
Exercise of stock options		-		2		2,841		-			-			2,843
Stock option expense and long-term compensation expense		-		-		3,562		-			-			3,562
Conversion of Series B cumulative preferred stock		-		7		7,215		-			-			7,222
Net proceeds from direct purchase and dividend reinvestment		-		66		117,089		-			-			117,155
Preferred Series A dividends declared $1.477 per share		-		-		-		-			(10,945	)		(10,945	)
Preferred Series B dividends declared $1.125 per share		-		-		-		-			(2,820	)		(2,820	)
Common dividends declared, $2.01 per share		-		-		-		-			(1,166,446	)		(1,166,446	)
BALANCE, September 30, 2010	$	177,088	$	6,206	$	8,994,954	$	1,877,537		$	(1,468,399	)	$	9,587,386
BALANCE, December 31, 2010	$	177,088	$	6,316	$	9,175,245	$	1,164,642		$	(658,391	)	$	9,864,900

Net loss		-		-		-		-			(101,101	)		(101,101	)
Other comprehensive income		-		-		-		1,908,846			-			1,908,846
Exercise of stock options		-		6		7,858		-			-			7,864
Stock option expense and long-term compensation expense		-		4		3,858		-			-			3,862
Conversion of Series B cumulative preferred stock		-		7		6,361		-			-			6,368
Net proceeds from direct purchase and dividend reinvestment		-		261		455,445		-			-			455,706
Net proceeds from follow-on offerings		-		3,105		5,348,741		-			-			5,351,846
Contingent beneficial conversion feature on Convertible Senior Notes		-		-		44,853		-			-			44,853
Preferred Series A dividends declared $1.477 per share		-		-		-		-			(10,945	)		(10,945	)
Preferred Series B dividends declared $1.125 per share		-		-		-		-			(1,761	)		(1,761	)
Common dividends declared, $1.87 per share		-		-		-		-			(1,620,416	)		(1,620,416	)

BALANCE, September 30, 2011	$	177,088	$	9,699	$	15,042,361	$	3,073,488		$	(2,392,614	)	$	15,910,022

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 September 30,						For the Nine Months Ended September 30,
	2011			2010			2011			2010
Cash flows from operating activities:
Net income (loss)	$	(921,813	)	$	(14,060	)	$	(101,101	)		48,776
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of Investment premiums and discounts, net		200,942			155,868			502,186			457,052
Amortization of intangibles		676			407			1,511			1,220
Amortization of deferred expenses		900			900			2,700			2,250
Amortization of contingent beneficial conversion feature on convertible senior notes		1,898			-			1,898			-
(Gains) losses on sales of Agency mortgage-backed securities and debentures		(91,668	)		(61,986	)		(126,189	)		(147,989	)
Stock option and long-term compensation expense		1,403			1,196			3,862			3,562
Unrealized (gains) losses on equity securities		63			-			63			-
Unrealized (gains) losses on interest rate swaps		1,505,333			448,253			1,802,968			1,158,023
Unrealized (gains) losses on interest-only Agency mortgage-backed securities		39,321			-			39,045			-
Net (gains) losses on trading securities		(1,942	)		(1,082	)		(15,042	)		(1,159	)
Gain on investment in affiliate, equity method		-			(97	)		(98	)		(312	)
Proceeds from repurchase agreements from Broker Dealer		157,069,300			365,003,080			720,578,286			936,383,970
Payments on repurchase agreements from Broker Dealer		(156,683,356	)		(364,576,286	)		(719,466,382	)		(930,904,601	)
Proceeds from reverse repurchase agreements to Broker Dealer		27,610,583			20,927,968			132,302,897			29,891,027
Payments on reverse repurchase agreements to Broker Dealer		(27,359,741	)		(21,376,914	)		(131,634,729	)		(30,153,996	)
Proceeds from reverse repurchase agreements to Shannon		58,848			-			65,893			-
Payments on reverse repurchase agreements to Shannon		(76,140	)		-			(88,213	)		-
Proceeds from securities borrowed		12,445,883			877,755			14,898,651			1,989,846
Payments on securities borrowed		(12,978,764	)		(886,755	)		(15,734,785	)		(2,212,011	)
Proceeds from securities loaned		12,398,720			996,966			14,902,887			2,366,791
Payments on securities loaned		(11,938,989	)		(987,876	)		(14,213,667	)		(2,144,516	)
Proceeds from U.S. Treasury Securities		(5,303,369	)		3,075,309			(18,193,311	)		3,451,909
Payments on U.S. Treasury Securities		5,716,809			(3,075,325	)		18,514,722			(3,511,758	)
Net payments on derivatives		(1,771	)		(1,527	)		(4,545	)		(2,545	)
Net change in:
Other assets		(4,795	)		15,308			(4,110	)		3,477
Accrued interest and dividend receivable		(22,148	)		(22,272	)		(62,792	)		(24,303	)
Advisory and service fees receivable		10			(1,779	)		(3,484	)		(2,573	)
Interest payable		5,618			14,471			12,605			24,376
Accounts payable and other liabilities		(4,058	)		17,536			65,916			41,347
Net cash provided by (used in) operating activities		1,667,753			529,058			4,047,642			6,717,863
Cash flows from investing activities:
Payments on purchases of Agency mortgage-backed securities and debentures		(17,054,754	)		(12,662,901	)		(49,344,466	)		(38,779,302	)
Proceeds from sales of Agency mortgage-backed securities and debentures		3,568,718			1,284,437			9,001,949			5,516,172
Principal payments on Agency mortgage-backed securities		5,074,528			5,569,728			14,429,098			22,307,773
Proceeds from Agency debentures called		288,925			349,875			906,523			1,223,875
Payments on purchase of corporate debt		-			-			(7,425	)		-
Principal payments on corporate debt		-			-			1,155			-
Net gains (losses) on other derivative securities		-			-			11,518			-
Purchase of investment in affiliate		-			-			(57,500	)		-
Purchase of customer relationships		-			-			(3,555	)		-
Purchase of equity securities		(3,990	)		-			(3,990	)		-
Payments on reverse repurchase agreements		-			-			-			(4,032,426	)
Proceeds from reverse repurchase agreements		-			-			-			4,291,430
Net cash provided by (used in) investing activities		(8,126,573	)		(5,458,861	)		(25,066,693	)		(9,472,478	)
Cash flows from financing activities:
Proceeds from repurchase agreements		72,790,611			55,726,371			200,627,105			166,732,844
Principal payments on repurchase agreements		(65,127,815	)		(51,499,332	)		(180,776,641	)		(165,769,674	)
Issuance of Convertible Senior Notes		-			-			-			582,000
Proceeds from exercise of stock options		1,752			1,032			7,864			2,843
Net proceeds from follow-on offerings		2,410,435			1,047,393			5,351,846			1,047,393
Net proceeds from direct purchases and dividend reinvestments		-			997			455,706			117,155
Dividends paid		(544,141	)		(385,151	)		(1,455,589	)		(1,173,028	)
Net cash provided by (used in) financing activities		9,530,842			4,891,310			24,210,291			1,539,533
Net increase (decrease) in cash and cash equivalents		3,072,022			(38,493	)		3,191,240			(1,215,082	)
Cash and cash equivalents, beginning of period		401,844			327,979			282,626			1,504,568
Cash and cash equivalents, end of period	$	3,473,866		$	289,486		$	3,473,866		$	289,486

Interest paid (excluding interest paid on interest rate swaps)	$	118,539		$	288,097		$	347,648		$	834,943
Net interest paid on interest rate swaps	$	229,109		$	200,039		$	644,962		$	514,651
Taxes paid	$	17,919		$	11,330		$	43,595		$	27,938

Noncash investing activities:
Receivable for Investments sold	$	402,817		$	1,637,542		$	402,817		$	1,637,542
Payable for Investments purchased	$	5,852,986		$	8,165,941		$	5,852,986		$	8,165,941
Net change in unrealized loss on available-for-sale securities and interest rate swaps, net of reclassification adjustment	$	1,023,657		$	(662,664	)	$	1,908,846		$	(13,780	)

Noncash financing activities:
Dividends declared, not yet paid	$	581,752		$	422,036		$	581,752		$	422,036
Contingent beneficial conversion feature	$	44,853			-		$	44,853
Conversion of Series B cumulative preferred stock	$	6,295		$	7,206		$	6,368		$	7,222

See notes to consolidated financial statements.

ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Annaly Capital Management, Inc. (“Annaly” or the “Company”) was incorporated in Maryland on November 25, 1996. The Company commenced its operations of purchasing and managing an investment portfolio of mortgage-backed securities on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital, and completed its initial public offering on October 14, 1997. The Company is a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended. Fixed Income Discount Advisory Company (“FIDAC”) is a registered investment advisor and is a wholly owned taxable REIT subsidiary of the Company. 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 UK Limited (“FIDAC UK”), which provides advice on commercial real estate transactions, including sale-leaseback and single tenant net leased properties across Europe. In 2011, the Company established FIDAC FSI LLC (“FIDAC FSI”), which invests in trading securities.

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

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

The consolidated financial statements include the accounts of the Company, FIDAC, FIDAC UK, FIDAC FSI, Merganser, RCap, Shannon, Charlesfort and the Fund. All intercompany balances and transactions have been eliminated.

Beginning with our consolidated financial statements for the six month period ending June 30, 2011, the Company reclassified previously presented financial information so that amounts previously presented in the Consolidated Statements of Operations and Comprehensive Income (Loss) as interest expense on swaps are presented in Other income (loss) as Realized gains (losses) on interest rate swaps. Consolidated financial statements for periods prior to June 30, 2011 will be conformed to the restated presentation. Accordingly, interest expense for the quarter and nine months ended September 30, 2010 decreased by $231.8 million and $654.8 million and Other income (loss) decreased by the same amounts, respectively to reflect the restated.

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

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

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

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

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 Agency mortgage-backed securities and Agency debentures until maturity, it may, from time to time, sell any of its Agency mortgage-backed securities and Agency debentures as part of its overall management of its portfolio. Investment Securities classified as available-for-sale are reported at estimated fair value, based on fair values obtained and compared to independent sources, 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 specific identification method.

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

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.

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 Statement of Operations and Comprehensive Income (Loss). Dividends are recorded on declaration date.

Management evaluates available-for-sale securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The Company determines if it (1) has the intent to sell the 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 statement of operations, while the balance of losses related to other factors will be recognized in other comprehensive income (“OCI”). There was no other-than-temporary impairment for the quarters and nine months ended September 30, 2011 and 2010.

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

Derivative Instruments – The Company accounts for interest rate swaps at fair value as either assets or liabilities on the Consolidated Statements of Financial Condition. The changes in the fair value of the 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 net income (loss). Unrealized gains (losses) on interest rate swaps are removed from net income (loss) as an adjustment to cash flows from 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 of all individual 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.

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 of 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.

RCap enters into U.S. Treasury, Eurodollar, and federal funds futures and options contracts for speculative or hedging purposes. RCap maintains a margin account which is settled daily with futures and options commission merchants. Changes in the unrealized gains or losses on the futures and options contracts are reflected in the Company’s Consolidated Statements of Operations. Unrealized gains (losses) are removed from net income (loss) as an adjustment to 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 the 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.

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.

Repurchase Agreements - The Company finances the acquisition of its Agency mortgage-backed securities and Agency debentures through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing transactions and are presented at their contractual principal amounts as specified in the respective agreements. Reverse repurchase agreements and repurchase agreements with the same counterparty and the same maturity are presented net in the 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 notes at their contractual amounts, including accrued interest. The Company has analyzed whether the embedded conversion option should be bifurcated and has determined that bifurcation was not necessary at inception. The notes have a conversion price adjustment feature that is evaluated at the time of the conversion price adjustment. A contingent beneficial conversion feature was recognized in the quarter ended September 30, 2011 as a result of adjustments to the conversion price for dividends declared.

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

Income Taxes - The Company has elected to be taxed as a REIT and intends to comply with the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), with respect thereto. Accordingly, the Company will not be subjected to federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and stock ownership tests are met. The Company and its direct and indirect subsidiaries, FIDAC, FIDAC UK, 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 its taxable income.

The provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“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 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 September 30, 2011.

Goodwill and Intangible Assets - The Company’s acquisitions of FIDAC and Merganser were accounted for using the purchase method. Under the purchase method, net assets and results of operations of acquired companies are included in the consolidated financial statements from the date of acquisition. 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 UK 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 expected to amortize over a 7.7 year weighted average time period. During the quarters and nine months ended September 30, 2011 and 2010, there were no impairment losses.

Stock Based Compensation - The Company is required to measure and recognize in the consolidated financial statements the compensation cost relating to share-based payment transactions. The Company recognizes compensation expense on a straight-line basis over the requisite service period for the entire award (that is, over the requisite service period of the last separately vesting portion of the award).

Use of Estimates - The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. All assets classified as 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. Fair values from independent sources are compared to internal prices for reasonableness. Actual results could differ from those estimates.

A Summary of Recent Accounting Pronouncements Follows:

Presentation

Comprehensive Income (ASC 220)

In June 2011, FASB released Accounting Standards Update (ASU) 2011-05, which attempts to improve the comparability, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income (OCI). The amendment requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of net income and comprehensive income or two separate consecutive statements. Either presentation requires the presentation on the face of the financial statements any reclassification adjustments for items that are reclassified from OCI to net income in the statements. There is no change in what must be reported in OCI or when an item of OCI must be reclassified to net income. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. This update will result in additional disclosure, but has no material effect on the Company’s consolidated financial statements.

Assets

Intangibles – Goodwill and Other (ASC 350)

In September 2011, FASB released ASU 2011-08, which allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The objective of the update is to simplify how entities test goodwill for impairment. Under this update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. This update if effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company is not eligible to elect early adoption. This update has no material effect on the Company’s consolidated financial statements.

Broad Transactions

Fair Value Measurements and Disclosures (ASC 820)

In May 2011, FASB released ASU 2011-04 further converging US GAAP and IFRS by providing common fair value measurement and disclosure requirements. The amendments in this Update change the wording used to describe the requirements in US GAAP for measuring fair value and for disclosing information about fair value measurements. These include those that clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2011. This update may result in additional disclosure and the Company is evaluating the effect on the Company’s consolidated financial statements.

Transfers and Servicing (ASC 860)

In April 2011, FASB issued ASU 2011-03 regarding repurchase agreements. In a typical repurchase agreement transaction, an entity transfers financial assets to the counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Previous to this update, one of the factors in determining whether sale treatment could be used was whether the transferor maintained effective control of the transferred assets and in order to do so, the transferor must have the ability to repurchase such assets. Based on this update, the FASB concluded that the assessment of effective control should focus on a transferor’s contractual rights and obligations with respect to transferred financial assets, rather than whether the transferor has the practical ability to perform in accordance with those rights or obligations. Therefore, this update removes the transferor’s ability criterion from consideration of effective control. This update is effective for the first interim or annual period beginning on or after December 15, 2011. As the Company records repurchase agreements as secured borrowings and not sales, this update will have no effect on the Company’s consolidated financial statements.

Financial Services – Investment Companies (ASC 946)

In October 2011, FASB issued a proposed ASU 2011-200 which would amend the criteria in Topic 946 for determining whether an entity qualifies as an investment company. The proposed ASU would affect the measurement, presentation and disclosure requirements for investment companies. This proposed update amends the investment company definition in ASC 946 and removes the current exemption for Real Estate Investment Trusts from this topic. The update may result in material modification to the presentation of the Company’s consolidated financial statements and the Company is currently evaluating the full effect of the update.

2. AGENCY MORTGAGE-BACKED SECURITIES

The following tables present the Company’s available-for-sale Agency mortgage-backed securities portfolio as of September 30, 2011 and December 31, 2010 which were carried at their fair value:

September 30, 2011	Freddie Mac			Fannie Mae			Ginnie Mae			Total Agency Mortgage-Backed Securities
	(dollars in thousands)
Mortgage-backed
securities, gross	$	30,371,944		$	68,940,202		$	796,512		$	100,108,658
Unamortized discount		(12,166	)		(15,528	)		(400	)		(28,094	)
Unamortized premium		879,830			2,516,205			28,106			3,424,141
Amortized cost		31,239,608			71,440,879			824,218			103,504,705

Gross unrealized gains		993,468			2,255,539			37,946			3,286,953
Gross unrealized losses		(14,206	)		(187,832	)		(910	)		(202,948	)

Estimated fair value	$	32,218,870		$	73,508,586		$	861,254		$	106,588,710

	Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Estimated Fair Value
	(dollars in thousands)
Adjustable rate	$	9,420,551		$	401,054		$	(3,240	)	$	9,818,365

Fixed rate		94,084,154			2,885,899			(199,708	)		96,770,345

Total	$	103,504,705		$	3,286,953		$	(202,948	)	$	106,588,710

December 31, 2010	Freddie Mac			Fannie Mae			Ginnie Mae			Total Agency mortgage-backed securities
	(dollars in thousands)
Mortgage-backed
securities, gross	$	19,846,543		$	54,341,140		$	824,029		$	75,011,712
Unamortized discount		(14,651	)		(18,329	)		(403	)		(33,383	)
Unamortized premium		517,507			1,795,116			26,200			2,338,823
Amortized cost		20,349,399			56,117,927			849,826			77,317,152

Gross unrealized gains		463,471			1,211,324			29,408			1,704,203
Gross unrealized losses		(140,027	)		(438,918	)		(2,080	)		(581,025	)

Estimated fair value	$	20,672,843		$	56,890,333		$	877,154		$	78,440,330

	Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Estimated Fair Value
	(dollars in thousands)
Adjustable rate	$	10,954,627		$	257,822		$	(75,440	)	$	11,137,009

Fixed rate		66,362,525			1,446,381			(505,585	)		67,303,321

Total	$	77,317,152		$	1,704,203		$	(581,025	)	$	78,440,330

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 of principal, and prepayments of principal. The following table summarizes the Company’s Agency mortgage-backed securities on September 30, 2011 and December 31, 2010 according to their estimated weighted-average life classifications:

	September 30, 2011				December 31, 2010
	Fair Value		Amortized Cost		Fair Value		Amortized Cost
Weighted-Average Life	(dollars in thousands)
Less than one year	$	1,258,333	$	1,239,663	$	915,398	$	901,824
Greater than one year and less than five years		95,745,349		92,856,677		59,732,123		58,321,570
Greater than or equal to five years		9,585,028		9,408,365		17,792,809		18,093,758

Total	$	106,588,710	$	103,504,705	$	78,440,330	$	77,317,152

The weighted-average lives of the Agency mortgage-backed securities at September 30, 2011 and December 31, 2010 in the table above are based upon data provided through subscription-based financial information services, assuming constant principal prepayment rates to the reset date of each security. The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, mortgage rate of the outstanding loans, loan age, margin and volatility. The actual weighted average lives of the 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 September 30, 2011 and December 31, 2010.

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

September 30, 2011	$	5,243,617	$	(192,455	)	$	305,241	$	(10,493	)	$	5,548,858	$	(202,948	)
December 31, 2010	$	28,608,996	$	(577,096	)	$	166,481	$	(3,929	)	$	28,775,477	$	(581,025	)

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 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 or the Company is not required to sell for regulatory or other reasons. Also, the Company is guaranteed payment of the principal amount of the securities by the government agency which created them.

During the quarter and nine months ended September 30, 2011, the Company sold $3.6 billion and $8.5 billion of Agency mortgage-backed securities, resulting in a realized gain of $91.7 million and $118.5 million, respectively. During the quarter and nine months ended September 30, 2010, the Company sold $2.8 billion and $5.8 billion of Agency mortgage-backed securities, resulting in a realized gain of $61.9 million and $146.6 million respectively.

Interest-only 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 September 30, 2011, interest-only securities accounted for under the fair value option had unrealized losses of $39.0 million and an amortized cost of $140.1 million.

3. AGENCY DEBENTURES

At September 30, 2011, the Company owned Agency debentures with a fair value of $824.1 million, including unrealized gains of $5.5 million. At December 31, 2010, the Company owned Agency debentures with a fair value of $1.1 billion, including an unrealized gain of $9.7 million.

For the quarter and nine months ended September 30, 2011, the Company sold or had called $288.9 million and $1.2 billion of Agency debentures, resulting in realized gains of $0 and $7.7 million, respectively. For the quarter and nine months ended September 30, 2010, the Company sold or had called $350.0 million and $1.7 billion of Agency debentures, resulting in a realized gain of $125,000 and $1.3 million, respectively.

4. INVESTMENT 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 Investment Corp. (CreXus) and are reported at fair value. The Company owned approximately 45.0 million shares of Chimera at a fair value of approximately $124.6 million at September 30, 2011 and approximately 45.0 million shares of Chimera at a fair value of approximately $184.9 million at December 31, 2010. At September 30, 2011, the investment in Chimera had an unrealized loss of $14.2 million. The Company owned approximately 9.5 million shares of CreXus at a fair value of approximately $84.6 million at September 30, 2011 and approximately 4.5 million shares of CreXus at a fair value of approximately $59.3 million at December 31, 2010. At September 30, 2011, the investment in CreXus had an unrealized loss of $40.8 million.

The Company determined other-than-temporary impairment was not necessary for the quarter or nine months ended September 30, 2011 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.

5. REVERSE REPURCHASE AGREEMENTS

At September 30, 2011, RCap had outstanding reverse repurchase agreements with non-affiliates of $338.0 million. At December 31, 2010, RCap had outstanding reverse repurchase agreements with non-affiliates of $1.0 billion. At September 30, 2011, Shannon had outstanding reverse repurchase agreements with non-affiliates of $22.3 million.

6. FAIR VALUE MEASUREMENTS

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

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

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

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

Available-for-sale-equity securities are valued based on quoted prices (unadjusted) in an active market. Agency mortgage-backed securities, debentures and interest rate swaps are valued internally and compared to quoted prices for similar assets and dealer quotes. Management incorporates common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, rate reset period and expected life of the security.

The Company’s Investment Securities characteristics are as follows:

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

At September 30, 2011	4.81%	3.85%	3.78%	2.79%	9.63%	40 months
At December 31, 2010	4.92%	4.28%	4.00%	3.04%	10.16%	39 months

The classification of assets and liabilities by level remains unchanged at September 30, 2011, when compared to the year ended December 31, 2010, with the exception of equity securities, which were acquired during the quarter ended September 30, 2011. The Company’s financial assets and liabilities carried at fair value on a recurring basis are valued as follows:

	Level 1		Level 2		Level 3
At September 30, 2011	(dollars in thousands)
Assets:
Agency mortgage-backed securities	$	-	$	106,588,710	$	-
Agency debentures		-		824,092		-
Investment in affiliates		209,374		-		-
U.S. Treasury Securities		172,892		-		-
Equity securities		3,929		-		-
Securities borrowed		-		1,052,810		-
Other derivative contracts		-		1,450		-
Liabilities:
Interest rate swaps		-		2,540,558		-
U.S. Treasury securities sold, not yet purchased		549,505		-		-
Securities loaned		-		907,061		-

	Level 1		Level 2		Level 3
	(dollars in thousands)
Assets:
Agency mortgage-backed securities	$	-	$	78,440,330	$	-
Agency debentures		-		1,108,261		-
Investments in affiliates		184,879		-		-
U.S. Treasury securities		1,100,447		-		-
Securities borrowed		-		216,676		-
Interest rate swaps		-		2,561		-
Other derivative contracts		2,607		-		-
Liabilities:
Interest rate swaps		-		754,439		-
U.S. Treasury securities sold, not yet purchased		909,462		-		-
Securities loaned		-		217,841		-
Other derivative contracts		-		2,446		-

The carrying amount of cash and cash equivalents, reverse repurchase agreements, receivable for Agency mortgage-backed securities sold, accrued interest and dividends receivable, receivable for advisory and service fees, repurchase agreements with maturities shorter than one year, payable for investments purchased, dividends payable, accounts payable and other liabilities, and accrued interest payable, generally approximates fair value at September 30, 2011 due to the short term nature of these financial instruments.

7. REPURCHASE AGREEMENTS

The Company had outstanding $86.5 billion and $65.5 billion of repurchase agreements with weighted average borrowing rates of 1.61% and 1.84%, after giving effect to the Company’s interest rate swaps, and weighted average remaining maturities of 122 days and 127 days as of September 30, 2011 and December 31, 2010, respectively. Investment Securities and U.S. Treasury Securities pledged as collateral under these repurchase agreements and interest rate swaps had an estimated fair value of $93.6 billion at September 30, 2011 and $69.5 billion at December 31, 2010.

At September 30, 2011 and December 31, 2010, the repurchase agreements had the following remaining maturities:

	September 30, 2011		December 31, 2010
	(dollars in thousands)
1 day	$	508,647	$	-
2 to 29 days		30,514,704		32,669,341
30 to 59 days		17,452,781		13,767,522
60 to 89 days		6,642,708		4,776,597
90 to 119 days		15,863,279		6,068,376
Over 120 days		15,513,786		8,251,701
Total	$	86,495,905	$	65,533,537

The Company did not have an amount at risk greater than 10% of the equity of the Company with any counterparty as of September 30, 2011 or December 31, 2010.

The Company has entered into long term repurchase agreements which provide the counterparties with the right to call the balance prior to maturity date. These repurchase agreements totaled $5.0 billion and the fair value of the option to call was ($296.4 million) at September 30, 2011. The repurchase agreements totaled $5.9 billion and the fair value of the option to call was ($313.2 million) at December 31, 2010. Management has determined that the call option is not required to be bifurcated as it is deemed clearly and closely related to the debt instrument, therefore the fair value of the option is not recorded in the consolidated financial statements. The long term repurchase agreements are modeled and priced as pay fixed versus receive floating interest rate swaps whereby the fixed receiver has the option to cancel the swap after an initial lockout period.

Additionally, as of September 30, 2011 and December 31, 2010, the Company has entered into repurchase agreements with a term of over one year. The amount of the repurchase agreements is $1.0 billion and $500 million and they have an estimated fair value of $1.1 billion and $513.3 million as of September 30, 2011 and December 31, 2010, respectively.

8. DERIVATIVE INSTRUMENTS

In connection with the Company’s interest rate risk management strategy, the Company economically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts. As of September 30, 2011, such instruments are comprised of interest rate swaps, which in effect modify the cash flows on repurchase agreements. The use of interest rate swaps creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts. In the event of a default by the counterparty, the Company could have difficulty obtaining its Investment Securities pledged as collateral for swaps. The Company does not anticipate any defaults by its counterparties.

The purpose of the swaps is to mitigate the risk of rising interest rates that affect the Company’s cost of funds.

The location and fair value of the Company’s interest rate swaps reported in the Consolidated Statements of Financial Condition as of September 30, 2011 and December 31, 2010 are as follows:

	Location on Consolidated Statements of Financial Condition	Notional Amount		Net Estimated Fair Value/Carrying Value
		(dollars in thousands)
September 30, 2011	Assets	$	-	$	-
September 30, 2011	Liabilities	$	40,461,190	$	(2,540,558	)
December 31, 2010	Assets	$	200,000	$	2,561
December 31, 2010	Liabilities	$	26,882,460	$	(754,439	)

The effect of the Company’s interest rate swaps on the Consolidated Statements of Operations and Comprehensive Income is as follows:

	Location on Consolidated Statements of Operations and Comprehensive Income
	Realized Gains (Loss) Recognized on			Unrealized Gains (Losses) on
	Interest Rate Swaps*			Interest Rate Swaps
	(dollars in thousands)
For the Quarter Ended September 30, 2011	$	(231,849	)	$	(1,505,333	)
For the Quarter Ended September 30, 2010	$	(188,636	)	$	(448,253	)
For the Nine Months Ended September 30, 2011	$	(654,757	)	$	(1,802,968	)
For the Nine Months Ended September 30, 2010	$	(545,009	)	$	(1,158,023	)

* 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 weighted average pay rate at September 30, 2011 was 2.57% and the weighted average receive rate was 0.25%. The weighted average pay rate at September 30, 2010 was 3.34% and the weighted average receive rate was 0.31%. Without netting the market value of the swaps by dealer at September 30, 2011, the gross unrealized loss on interest rate swaps was $2.5 billion, with a notional amount of $40.5 billion. Without netting the market value of the swaps by dealer at September 30, 2010, the gross unrealized loss on interest rate swaps was $1.6 billion, with a notional amount of $25.9 billion.

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

9. CONVERTIBLE SENIOR NOTES

In 2010, Company issued $600.0 million in aggregate principal amount of its 4% convertible senior notes due 2015 (“Convertible Senior Notes”) for net proceeds following underwriting expenses of approximately $582.0 million. Interest on the Convertible Senior Notes is paid semi-annually at a rate of 4% per year and the Convertible Senior Notes will mature on February 15, 2015 unless earlier repurchased or converted. The Convertible Senior Notes are convertible into shares of Common Stock at an initial conversion rate and conversion rate at September 30, 2011 of 46.6070 and 60.1093 shares of Common Stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price and conversion price at September 30, 2011 of approximately $21.4560 and $16.6364 per share of Common Stock, respectively, subject to adjustment in certain circumstances. During the quarter ended September 30, 2011, it was determined that there was a contingent beneficial conversion feature. The intrinsic value of the contingent beneficial conversion feature was $44.9 million. This intrinsic value is included in Additional paid in capital on the Company’s Consolidated Statements of Financial Condition and, therefore, reduces the liability associated with the Convertible Senior Notes. The $44.9 million discount to the principal amount of the Convertible Senior Notes is recognized in interest expense over the remaining life of the notes using the effective yield method. The market value of the Convertible Senior Notes at September 30, 2011 and December 31, 2010 was $687.8 million and $699.2 million, respectively, based on closing price.

10. PREFERRED STOCK AND COMMON STOCK

(A) Common Stock Issuances

On June 23, 2011, the Company amended its charter to increase the number of authorized shares of capital stock, par value $0.01 per share, from 1,000,000,000 shares to 2,000,000,000 shares, consisting of 1,987,987,500 shares classified as Common Stock, 7,412,500 shares classified as 7.875% Series A Cumulative Redeemable Preferred Stock, and 4,600,000 shares classified as 6.00% Series B Cumulative Convertible Preferred Stock.

On July 11, 2011 the Company entered into an agreement pursuant to which it sold 138,000,000 shares of its common stock for net proceeds following expenses of approximately $2.41 billion. This transaction settled on July 15, 2011.

On February 15, 2011 the Company entered into an agreement pursuant to which it sold 86,250,000 shares of its common stock for net proceeds following expenses of approximately $1.47 billion. This transaction settled on February 18, 2011.

On January 4, 2011 the Company entered into an agreement pursuant to which it sold 86,250,000 shares of its common stock for net proceeds following expenses of approximately $1.47 billion. This transaction settled on January 7, 2011.

During the quarter and nine months ended September 30, 2011, 134,000 options and 596,000 options were exercised for an aggregate exercise price of $1.8 million and $7.9 million, respectively, and 0 shares and 654,000 restricted shares were granted under the Long-Term Stock Incentive Plan (“Incentive Plan”), respectively. During the quarter and nine months ended September 30, 2010, 79,000 options and 227,000 options were exercised under the Incentive Plan for an aggregate exercise price of $1.0 million and $2.8 million, respectively.

During the quarter and nine months ended September 30, 2011, 260,000 shares and 263,000 shares of Series B Preferred Stock were converted into 732,000 shares and 740,000 shares of common stock, respectively. During the quarter and nine months ended September 30, 2010, 297,000 and 298,000 shares of Series B Preferred Stock were converted into 741,000 and 743,000 shares of common stock, respectively.

During the nine months ended September 30, 2011, the Company raised $455.7 million by issuing 26.2 million shares through the Direct Purchase and Dividend Reinvestment Program. The Company did not issue any shares through the program during the quarter ended September 30, 2011. During the quarter and nine months ended September 30, 2010, the Company raised $691,000 and $117.2 million by issuing 39,000 shares and 6.6 million shares, through the Direct Purchase and Dividend Reinvestment Program.

(B) Preferred Stock

At September 30, 2011 and December 31, 2010, the Company had issued and outstanding 7,412,500 shares of Series A Cumulative Redeemable Preferred Stock (Series A Preferred Stock), with a par value $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series A Preferred Stock must be paid a dividend at a rate of 7.875% per year on the $25.00 liquidation preference before the common stock is entitled to receive any dividends. The Series A Preferred Stock is redeemable at $25.00 per share plus accrued and unpaid dividends (whether or not declared) exclusively at the Company's option commencing on April 5, 2009 (subject to the Company's right under limited circumstances to redeem the Series A Preferred Stock earlier in order to preserve its qualification as a REIT). The Series A Preferred Stock is senior to the Company's common stock and is on parity with the Series B Preferred Stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series A Preferred Stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series A Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series A Preferred Stock, together with the Series B Preferred Stock, will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse changes to the terms of the Series A Preferred Stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series A Preferred Stock and Series B Cumulative Convertible Preferred Stock (Series B Preferred Stock). Through September 30, 2011, the Company had declared and paid all required quarterly dividends on the Series A Preferred Stock.

At September 30, 2011 and December 31, 2010, the Company had issued and outstanding 1,389,249 and 1,652,047, respectively, shares of Series B Preferred Stock, with a par value $0.01 per share and a liquidation preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). The Series B Preferred Stock must be paid a dividend at a rate of 6% per year on the $25.00 liquidation preference before the common stock is entitled to receive any dividends.

The Series B Preferred Stock is not redeemable. The Series B Preferred Stock is convertible into shares of common stock at a conversion rate that adjusts from time to time upon the occurrence of certain events, including if the Company distributes to its common shareholders in any calendar quarter cash dividends in excess of $0.11 per share. Initially, the conversion rate was 1.7730 shares of common shares per $25 liquidation preference. At September 30, 2011, the conversion ratio was 2.8944 shares of common stock per $25 liquidation preference. Commencing April 5, 2011, the Company has the right in certain circumstances to convert each Series B Preferred Stock into a number of common shares based upon the then prevailing conversion rate. The Series B Preferred Stock is also convertible into common shares at the option of the Series B preferred shareholder at any time at the then prevailing conversion rate. The Series B Preferred Stock is senior to the Company's common stock and is on parity with the Series A Preferred Stock with respect to dividends and distributions, including distributions upon liquidation, dissolution or winding up. The Series B Preferred Stock generally does not have any voting rights, except if the Company fails to pay dividends on the Series B Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Series B Preferred Stock, together with the Series A Preferred Stock, will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse changes to the terms of the Series B Preferred Stock cannot be made without the affirmative vote of holders of at least two-thirds of the outstanding shares of Series B Preferred Stock and Series A Preferred Stock. Through September 30, 2011, the Company had declared and paid all required quarterly dividends on the Series B Preferred Stock. During the quarter and nine months ended September 30, 2011, 260,000 shares and 263,000 shares of Series B Preferred Stock were converted into 732,000 shares and 740,000 shares of common stock, respectively. During the quarter and nine months ended September 30, 2010, 297,000 and 298,000 shares of Series B Preferred Stock were converted into 741,000 and 743,000 shares of common stock, respectively.

During the quarter and nine months ended September 30, 2011, the Company declared dividends to common shareholders totaling $581.8 million or $0.60 per share and $1.6 billion or $1.87 per share, respectively, of which $581.8 million was paid to shareholders on October 27, 2011. During the quarter and nine months ended September 30, 2011, the Company declared dividends to Series A Preferred shareholders totaling approximately $3.6 million or $0.492 per share and $10.9 million or $1.477 per share, and Series B shareholders totaling approximately $524 thousand or $0.375 per share and approximately $1.8 million or $1.125 per share, respectively.

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

11. NET INCOME PER COMMON SHARE

The following table presents a reconciliation of the net income and shares used in calculating basic and diluted earnings per share for the quarters and nine months ended September 30, 2011 and 2010.

	For the Quarters Ended						For the Nine Months Ended
	September 30, 2011			September 30, 2010			September 30, 2011			September 30, 2010
Net income (loss)	$	(921,813	)	$	(14,060	)	$	(101,101	)	$	48,776
Less: Preferred stock dividends		4,172			4,515			12,706			13,765
Net income (loss) available to common shareholders, prior to adjustment for dilutive potential common shares, if necessary	$	(925,985	)	$	(18,575	)	$	(113,807	)	$	35,011
Add: Preferred Series B dividends, if Series B shares are dilutive		-			-			-			-
Add: Interest on Convertible Senior Notes, if Notes are dilutive		-			-			-			-
Net income (loss) available to common shareholders, as adjusted	$	(925,985	)	$	(18,575	)	$	(113,807	)	$	35,011

Weighted average shares of common stock outstanding-basic		948,546			611,905			841,913			575,742
Add: Effect of dilutive stock options		-			-			-			217
Add: Series B Cumulative Convertible Preferred Stock, if dilutive		-			-			-			-
Add: Convertible Senior Notes, if dilutive		-			-			-			-
Weighted average shares of common stock outstanding-diluted		948,546			611,905			841,913			575,959

Options to purchase 572,000 and 572,000 shares of common stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the quarter and nine months ended September 30, 2011. Options to purchase 572,000 and 566,000 shares of common stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the quarter and nine months ended September 30, 2010, respectively.

12. 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 award, including restricted shares up to an aggregate of 25,000,000 shares, subject to adjustments as provided in the 2010 Equity Incentive Plan. On June 27, 2011 the Company granted to each non-management director of the Company options to purchase 1,250 shares of the Company’s common stock under the 2010 Equity Incentive Plan. The stock options were issued at the current market price on the date of grant and immediately vested with a contractual term of 5 years. The grant date fair value is calculated using the Black-Scholes option valuation model. 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 ceiling of 8,932,921 shares. No further awards will be made under the Prior Plan, although existing awards will 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. During the nine months ended September 30, 2011, the Company granted 654,000 restricted shares that vest over four years.

	For the Nine Months Ended
	September 30, 2011					September 30, 2010
	Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price
Options outstanding at the beginning of period		6,891,975		$	15.20		7,271,503		$	15.20
Granted		7,500			18.67		7,500			17.24
Exercised		(596,470	)		13.18		(226,791	)		12.54
Forfeited		-			-		(14,400	)		14.85
Expired		(3,750	)		12.15		(6,250	)		18.26
Options outstanding at the end of period		6,299,255		$	15.54		7,031,562		$	15.28
Options exercisable at the end of the period		4,534,143		$	16.12		3,961,568		$	16.04

The weighted average remaining contractual term was approximately 5.7 years for stock options outstanding and approximately 5.1 years for stock options exercisable as of September 30, 2011. As of September 30, 2011, there was approximately $5.3 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 1.3 years.

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

13. INCOME TAXES

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

During the quarter and nine months ended September 30, 2011, the Company’s taxable REIT subsidiaries recorded $2.6 million and $9.4 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 and nine months ended September 30, 2011, the Company recorded $12.8 million and $32.4 million of income tax expense for a portion of earnings retained based on Section 162(m) limitations.

During the quarter and nine months ended September 30, 2010, the Company’s taxable REIT subsidiaries recorded $2.4 million and $5.4 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 and nine months ended September 30, 2010, the Company recorded $8.6 million and $21.8 million of income tax expense for a portion of earnings retained based on Section 162(m) limitations.

The Company files tax returns in several U.S jurisdictions, including New York State and New York City. The 2007 through 2010 tax year remains open to U.S. federal, state and local tax examinations.

The effective tax rate of 53% was calculated based on the Company’s estimated taxable income after dividends paid deduction and differ from the federal statutory rate as a result of state and local taxes and permanent difference pertaining to employee remuneration as discussed above.

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

14. LEASE COMMITMENTS AND CONTINGENCIES

Commitments

The Company has a non-cancelable lease for office space which commenced in May 2002 and expires in December 2015. Additionally, on January 1, 2011 the Company acquired additional office space. 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. FIDAC UK has a lease for office space that expires in March 2019, which FIDAC UK has the right to terminate early in March 2014 by providing six months’ notice to the lessor. The Company’s aggregate future minimum lease payments total $9.4 million. The following table details the lease payments.

Year Ending December	Lease Commitment		Sublease Income		Net Amount
	(dollars in thousands)
2011 (remaining)	$	750	$	42	$	708
2012		3,003		70		2,933
2013		3,004		-		3,004
2014		2,522		-		2,522
2015		161