Cohen & Co Inc. - Quarter Report: 2008 June (Form 10-Q)

Form 10-Q

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: June 30, 2008

¨	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: 001-32026

ALESCO FINANCIAL INC.

(Exact name of registrant as specified in its governing instruments)

Maryland

16-1685692

(State or other jurisdiction of

Incorporation or organization)

(IRS Employer

Identification Number)

Cira Centre

2929 Arch Street, 17^th Floor

Philadelphia, Pennsylvania 19104

(Address of principal executive offices, Zip Code)

(215) 701-9555

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ¨				Accelerated filer x

Non-accelerated filer ¨				Smaller reporting company ¨

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of August 7, 2008 there were 59,747,289 shares of common stock ($0.001 par value per share) of Alesco Financial Inc. outstanding.

ALESCO FINANCIAL INC.

TABLE OF CONTENTS


Part I. Financial Information		1

Item 1.	Financial Statements (Unaudited)	1

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43

Item 4.	Controls and Procedures	44

Part II. Other Information		44

Item 1.	Legal Proceedings	44

Item 1A.	Risk Factors	45

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45

Item 3.	Defaults Upon Senior Securities	45

Item 4.	Submission of Matters to a Vote of Security Holders	45

Item 5.	Other Information	46

Item 6.	Exhibits	46

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS (UNAUDITED).

Alesco Financial Inc.

Consolidated Balance Sheets

(Unaudited and in thousands, except share and per share information)


	As of June 30, 2008			As of December 31, 2007
Assets
Investments in debt securities and security-related receivables (including amounts at fair value of $4,172,136 and $5,888,650, respectively)	$	4,172,136		$	6,628,991
Investments in loans
Residential mortgages		962,142			1,047,195
Commercial mortgages		7,464			7,332
Leveraged loans		853,035			836,953
Loan loss reserve		(33,535	)		(18,080	)

Total investments in loans, net		1,789,106			1,873,400
Cash and cash equivalents		135,971			80,176
Restricted cash and warehouse deposits		86,955			95,476
Accrued interest receivable		35,058			49,806
Other assets		46,834			207,527

Total assets	$	6,266,060		$	8,935,376

Liabilities and stockholders’ equity (deficit)
Indebtedness
Trust preferred obligations (including amounts at fair value of $222,343 and $0, respectively)	$	222,343		$	382,600
Securitized mortgage debt		888,920			959,558
CDO notes payable (including amounts at fair value of $3,710,746 and $0, respectively)		4,391,076			9,409,027
Warehouse credit facilities		130,687			155,984
Recourse indebtedness		189,614			189,614

Total indebtedness		5,822,640			11,096,783
Accrued interest payable		30,794			54,380
Related party payable		2,956			2,800
Other liabilities		131,511			161,408

Total liabilities		5,987,901			11,315,371
Minority interests		74,789			19,543
Stockholders’ equity (deficit)
Preferred stock, $0.001 par value per share, 50,000,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.001 par value per share, 100,000,000 shares authorized, 60,953,473 and 60,548,032 issued and outstanding, including 1,361,342 and 1,228,234 unvested restricted share awards, respectively		60			59
Additional paid-in-capital		482,809			481,850
Accumulated other comprehensive loss		(24,028	)		(1,545,464	)
Accumulated deficit		(255,471	)		(1,335,983	)

Total stockholders’ equity (deficit)		203,370			(2,399,538	)

Total liabilities and stockholders’ equity (deficit)	$	6,266,060		$	8,935,376

See accompanying notes.

Alesco Financial Inc.

Consolidated Statements of Income (Loss)

(Unaudited and in thousands, except share and per share information)


	For the Three-Month Period Ended June 30, 2008			For the Three-Month Period Ended June 30, 2007			For the Six-Month Period Ended June 30, 2008			For the Six-Month Period Ended June 30, 2007
Net investment income:
Investment interest income	$	137,520		$	173,333		$	311,415		$	334,651
Investment interest expense		(101,588	)		(151,133	)		(241,372	)		(293,437	)
Provision for loan losses		(7,891	)		(3,285	)		(15,455	)		(5,459	)

Net investment income		28,041			18,915			54,588			35,755

Expenses:
Related party management compensation		4,197			4,344			8,942			7,727
General and administrative		3,545			2,982			7,160			5,396

Total expenses		7,742			7,326			16,102			13,123

Income before interest and other income, minority interest and taxes		20,299			11,589			38,486			22,632

Interest and other income		1,131			5,646			2,625			11,654
Net change in fair value of investments in debt securities and non-recourse indebtedness		(132,651	)		—			70,208			—
Net change in fair value of derivative contracts		37,055			17,239			(45,808	)		19,592
Credit default swap premiums		(1,536	)		(185	)		(2,872	)		(185	)
Impairments on investments and intangible assets		(4,286	)		(74,443	)		(12,844	)		(74,428	)
Loss on disposition of consolidated entities		(5,558	)		—			(5,558	)		—
Net realized loss on sale of assets		(1,742	)		(723	)		(3,191	)		(4,397	)

Income (loss) before minority interest and benefit (provision) for income taxes		(87,288	)		(40,877	)		41,046			(25,132	)
Minority interest		3,109			(6,127	)		(40,765	)		(9,697	)

Income (loss) before benefit (provision) for income taxes		(84,179	)		(47,004	)		281			(34,829	)
Benefit (provision) for income taxes		2,975			(213	)		3,402			(610	)

Net income (loss)	$	(81,204	)	$	(47,217	)	$	3,683		$	(35,439	)

Earnings (loss) per share—basic:
Basic earnings (loss) per share	$	(1.36	)	$	(0.86	)	$	0.06		$	(0.65	)

Weighted-average shares outstanding—Basic		59,512,594			54,902,323			59,422,581			54,800,726

Earnings (loss) per share—diluted:
Diluted earnings (loss) per share	$	(1.36	)	$	(0.86	)	$	0.06		$	(0.65	)

Weighted-average shares outstanding—Diluted		59,512,594			54,902,323			59,635,405			54,800,726

Distributions declared per common share	$	0.25		$	0.31		$	0.50		$	0.61

See accompanying notes.

Alesco Financial Inc.

Consolidated Statements of Other Comprehensive Income (Loss)

(Unaudited and in thousands)


	For the Three-Month Period Ended June 30, 2008			For the Three-Month Period Ended June 30, 2007			For the Six-Month Period Ended June 30, 2008			For the Six-Month Period Ended June 30, 2007
Net income (loss)	$	(81,204	)	$	(47,217	)	$	3,683		$	(35,439	)
Other comprehensive income (loss):
Net change in the fair value of cash-flow hedges		—			53,371			—			43,489
Reclassification adjustments associated with unrealized losses (gains) from cash flow hedges included in net income		41,924			(44	)		44,507			(67	)
Net change in the fair value of available-for-sale securities		—			(22,033	)		—			(8,523	)
Allocation to minority interests		(668	)		(26,973	)		(1,295	)		(58,853	)

Total other comprehensive income (loss)		41,256			4,321			43,212			(23,954	)

Comprehensive income (loss)	$	(39,948	)	$	(42,896	)	$	46,895		$	(59,393	)

See accompanying notes.

Alesco Financial Inc.

Consolidated Statements of Stockholders’ Equity (Deficit)

(Unaudited and in thousands, except share information)


	Common Stock			Additional Paid In Capital		Accumulated Other Comprehensive Loss			Accumulated Earnings (Deficit)			Total Stockholders’ Equity (Deficit)
	Shares	Par Value		Additional Paid In Capital		Accumulated Other Comprehensive Loss			Accumulated Earnings (Deficit)			Total Stockholders’ Equity (Deficit)
Balance, December 31, 2007	59,319,798	$	59	$	481,850	$	(1,545,464	)	$	(1,335,983	)	$	(2,399,538	)
Net income	—		—		—		—			3,683			3,683
Cumulative effect of adjustment from adoption of SFAS No. 159	—		—		—		1,478,224			1,107,205			2,585,429
Other comprehensive income	—		—		—		43,212			—			43,212
Stock-based compensation expense	272,333		1		959		—			—			960
Dividends declared on common stock	—		—		—		—			(30,376	)		(30,376	)

Balance, June 30, 2008	59,592,131	$	60	$	482,809	$	(24,028	)	$	(255,471	)	$	203,370

See accompanying notes.

Alesco Financial Inc.

Consolidated Statements of Cash Flows

(Unaudited and in thousands)


	For the Six-Month Period Ended June 30, 2008			For the Six-Month Period Ended June 30, 2007
Operating activities:
Net income	$	3,683		$	(35,439	)
Adjustments to reconcile net income to cash flow from operating activities:
Minority interest		40,765			9,697
Provision for loan losses		15,455			5,459
Stock-based compensation expense		960			1,065
Net premium and discount amortization on investments and loans		239			647
Amortization of deferred financing costs		1,068			3,641
Accretion of discounts on indebtedness		565			351
Net change in fair value of derivative contracts		29,530			(2,943	)
Net change in fair value of debt securities and non-recourse indebtedness		(70,208	)		—
Impairments on other assets		12,844			74,428
Net realized loss on sale of assets		3,191			4,397
Loss on disposition of consolidated entities		5,558			—
Changes in assets and liabilities:
Accrued interest receivable		13,018			777
Other assets		69,433			(672	)
Accrued interest payable		(25,035	)		1,749
Related party payable		405			(169	)
Other liabilities		(3,598	)		19,585

Net cash provided by operating activities		97,873			82,573
Investing activities:
Purchase of investments in debt securities and security-related receivables		(10,122	)		(1,943,008	)
Principal repayments from debt securities and security-related receivables		15,945			25,422
Purchase of loans		(133,312	)		(505,549	)
Principal repayments from loans		131,289			269,287
Proceeds from sale of loans		68,197			529,680
Proceeds from sale of debt securities and security-related receivables		15,215			903,060
(Increase) decrease in restricted cash and warehouse deposits		3,964			(140,666	)

Net cash provided by (used in) investing activities		91,176			(861,774	)
Financing activities:
Proceeds from repurchase agreements		—			245,689
Repayments of repurchase agreements		—			(3,215,965	)
Proceeds from issuance of CDO notes payable		42,386			2,495,625
Repayments of CDO notes payable		(32,493	)		(11,321	)
Proceeds from issuance of trust preferred obligations		—			162,603
Proceeds from warehouse credit facilities		131,890			448,920
Repayments of warehouse credit facilities		(157,187	)		(462,558	)
Proceeds from issuance of recourse indebtedness		—			208,995
Repayment of recourse indebtedness		—			(40,000	)
Proceeds from issuance of securitized mortgage debt		—			1,014,600
Repayments of securitized mortgage debt		(71,203	)		—
Proceeds from other derivative contracts		—			5,385
Repayments of other derivative contracts		(3,190	)		—
Proceeds from cash flow hedges		—			6,356
Proceeds from issuance of preference shares of CDOs		—			15,103
Distributions to minority interest holders in CDOs		(9,550	)		(8,768	)
Payments for deferred debt issuance costs		—			(29,994	)
Proceeds from issuance of common stock		—			71,997
Repurchase of common stock		—			(32,568	)
Distributions paid to common stockholders		(33,907	)		(33,058	)

Net cash provided by (used in) financing activities		(133,254	)		841,041

Net change in cash and cash equivalents	$	55,795		$	61,840
Cash and cash equivalents at the beginning of the period		80,176			51,821

Cash and cash equivalents at the end of the period	$	135,971		$	113,661

Supplemental cash flow information:
Non-cash decrease in assets upon disposition of consolidated entity	$	313,950		$	—
Non-cash decrease in liabilities upon disposition of consolidated entity		313,950			—
Distributions payable		15,239			—

See accompanying notes.

Alesco Financial Inc.

Notes to Consolidated Financial Statements

As of June 30, 2008

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

NOTE 1: THE COMPANY

Alesco Financial Trust was organized as a Maryland real estate investment trust on October 25, 2005 and commenced operations on January 31, 2006. On January 31, 2006, February 2, 2006, and March 1, 2006, Alesco Financial Trust completed the sale of 11,107,570 common shares of beneficial interest at an offering price of $10.00 per share in a private offering. Alesco Financial Trust received proceeds from this offering of $102.4 million, net of placement fees and offering costs.

On October 6, 2006, Alesco Financial Trust completed its merger with Alesco Financial Inc. (formerly Sunset Financial Resources, Inc.). Pursuant to the terms of the Amended and Restated Agreement and Plan of Merger, as amended by letter agreements dated September 5, 2006 and September 29, 2006, upon the completion of the merger each share of beneficial interest of Alesco Financial Trust was converted into 1.26 shares of common stock of Sunset Financial Resources, Inc. (“Sunset”), which resulted in the issuance of 14,415,530 shares of common stock. In accordance with U.S. generally accepted accounting principles (“GAAP”) the transaction was accounted for as a reverse acquisition, and Alesco Financial Trust was deemed to be the accounting acquirer and all of Sunset’s assets and liabilities were required to be revalued as of the acquisition date. As used in these consolidated financial statements, the term “the Company,” “we,” “us” and “our” refer to the operations of Alesco Financial Trust from January 31, 2006 through October 6, 2006, and the combined operations of the merged company subsequent to October 6, 2006. “Sunset” refers to the historical operations of Sunset Financial Resources, Inc. through October 6, 2006, the merger date.

Sunset was incorporated in Maryland on October 6, 2003, completed its initial public offering of common stock on March 22, 2004 and was traded on the New York Stock Exchange (the “NYSE”) under the ticker symbol “SFO.” Sunset elected to be taxed as a real estate investment trust (“REIT”) for U.S. Federal income tax purposes and the Company intends to continue to comply with these tax provisions. On October 9, 2006, the Company began trading on the NYSE under the ticker symbol “AFN.” On November 27, 2006, the Company closed a public offering of 30,360,000 shares of the Company’s common stock, par value $0.001 per share, at a public offering price of $9.00 per share, net of placement fees and offering costs. On June 25, 2007, the Company closed a public offering of 8,000,000 shares of the Company’s common stock, par value $0.001 per share, at a public offering price of $9.25 per share, net of placement fees and offering costs. Additionally, the Company repurchased 3,410,600 shares of its common stock at $9.55 and 420,800 shares of its common stock at a weighted average price per share of $4.64 during the three-month periods ended June 30, 2007 and September 30, 2007, respectively.

The Company is a specialty finance company that invests in multiple asset classes with the objective of generating risk-adjusted returns and predictable cash distributions for its stockholders, subject to maintaining the Company’s status as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, and its exemption from regulation under the Investment Company Act of 1940, as amended, or the Investment Company Act. The Company seeks to achieve its investment objectives by investing primarily in the following target asset classes:

•

subordinated debt financings originated by the Company’s manager or third parties, primarily in the form of trust preferred securities, or TruPS, issued by banks or bank holding companies and insurance companies, and surplus notes issued by insurance companies;

•

leveraged loans made to small and mid-sized companies in a variety of industries characterized by companies with relatively low volatility and overall leverage compared to their industry peers, including the consumer products and manufacturing industries; and

•

mortgage loans, other real estate-related senior and subordinated debt securities, residential mortgage-backed securities, or RMBS, and commercial mortgage-backed securities, or CMBS.

The Company typically finances investments in these target asset classes on a short-term basis with on and off-balance sheet warehouse facilities or other short-term financing arrangements and on a long-term basis with securitization vehicles, including collateralized debt obligations (“CDOs”) and collateralized loan obligations (“CLOs”).

The Company may also invest opportunistically from time to time in other types of investments within its manager’s and Cohen Brothers, LLC’s (“Cohen & Company”) areas of expertise and experience, subject to maintaining its qualification as a REIT and an exemption from regulation under the Investment Company Act of 1940.

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared by management in accordance with GAAP. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures included are adequate to make the information presented not misleading. The unaudited interim consolidated financial statements should be read in conjunction with our audited financial statements for the period ended December 31, 2007, included in our Annual Report on Form 10-K. See “Item 15—Exhibits and Financial Statement Schedules” included in our Annual Report on Form 10-K for the year ended December 31, 2007. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly our consolidated financial position and consolidated results of operations and cash flows are included. The results of operations for the interim periods presented are not necessarily indicative of the results for the full year.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Principles of Consolidation

The consolidated financial statements reflect the accounts of the Company and its majority-owned and/or controlled subsidiaries and those entities for which the Company is determined to be the primary beneficiary in accordance with Financial Accounting Standard Board (“FASB”) Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”). The portions of these entities to which the Company does not have an economic interest are presented as minority interests in the consolidated financial statements. The creditors of each variable interest entity (“VIE”) consolidated within the Company’s consolidated financial statements have no recourse to the general credit of the Company. The Company’s maximum exposure to loss as a result of its involvement with each VIE is the capital that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other types of securitization structures. All significant intercompany accounts and transactions have been eliminated in consolidation.

When the Company obtains an explicit or implicit interest in an entity, the Company evaluates the entity to determine if the entity is a VIE, and, if so, whether or not the Company is deemed to be the primary beneficiary of the VIE in accordance with FIN 46R. The Company consolidates VIEs of which the Company is deemed to be the primary beneficiary or non-VIEs which the Company controls. The primary beneficiary of a VIE is the variable interest holder that absorbs the majority of the variability in the expected losses or potentially the residual returns of the VIE. When determining the primary beneficiary of a VIE, the Company considers its aggregate explicit and implicit variable interests as a single variable interest. If the Company’s variable interest absorbs the majority of the variability in the expected losses or the residual returns of the VIE, the Company is considered the primary beneficiary of the VIE. The Company reconsiders its determination of whether an entity is a VIE and whether the Company is the primary beneficiary of such VIE if certain events occur. If the Company determines that it is no longer the primary beneficiary of a VIE, the deconsolidation of the VIE is accounted for as a sale of the entity for no proceeds.

The Company has determined that certain special purpose trusts formed by third party issuers of TruPS to issue such securities are VIEs (“Trust VIEs”) and that the holder of the majority of the TruPS issued by the Trust VIEs would be the primary beneficiary of the special purpose trust. In most instances, the Company is the primary beneficiary of the Trust VIEs because it holds, either explicitly or implicitly, the majority of the TruPS issued by the Trust VIEs. The acquisition of TruPS issued by Trust VIEs may be initially financed directly by CDOs, through on-balance sheet warehouse facilities or through off-balance sheet warehouse facilities. Under the TruPS-related off-balance sheet warehouse agreements, the Company usually deposits cash collateral with an investment bank and bears the first dollar risk of loss, up to the Company’s collateral deposit, if an investment held under the warehouse facility is liquidated at a loss. This arrangement causes the Company to hold an implicit interest in the Trust VIEs that issued TruPS held by warehouse providers. The primary assets of the Trust VIEs are subordinated debentures issued by third party sponsors of the Trust VIEs in exchange for the TruPS proceeds and the common equity securities of the Trust VIE. These subordinated debentures have terms that mirror the TruPS issued by the Trust VIEs. Upon consolidation of the Trust VIEs, these subordinated debentures, which are assets of the Trust VIE, are included in the Company’s consolidated financial statements and the related TruPS are eliminated. Pursuant to Emerging Issues Task Force Issue No. 85-1: “Classifying Notes Received for Capital Stock,” subordinated debentures issued to Trust VIEs as payment for common equity securities issued by Trust VIEs to third party sponsors are recorded net of the common equity securities issued.

Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which establishes a framework for measuring fair value by creating a three-level fair value hierarchy that ranks the quality and reliability of information used to determine fair value, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. SFAS No. 157 also defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

SFAS No. 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the financial instrument developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s estimates about what assumptions market participants would use in pricing the financial instrument developed based on the best information available in the circumstances. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

•

Level 1: Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Financial instruments utilizing Level 1 inputs generally include exchange-traded equity securities listed in active markets and most U.S. Government securities.

•

Level 2: Valuations based on quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

Financial instruments utilizing Level 2 inputs generally include certain mortgage-backed securities, or MBS, and corporate debt securities and certain financial instruments classified as derivatives, including interest rate swap contracts and credit default swaps, where fair value is based on observable market inputs.

•

Level 3: Inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Financial instruments utilizing Level 3 inputs generally include investments in TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable.

The fair value of the Company’s financial instruments is generally based on observable market prices or inputs or derived from such prices or inputs. When quoted market prices are not available because certain financial instruments do not actively trade in the public markets, fair value is based on comparisons to similar instruments or from internal valuation models.

The availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of financial instrument, its age, whether the financial instrument is traded on an active exchange or in the secondary market, the current market conditions, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that management believes market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that management believes are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3.

Many financial instruments have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that the Company and others are willing to pay for an asset. Ask prices represent the lowest price that the Company and others are willing to accept for an asset. For financial instruments whose inputs are based on bid-ask prices, the Company does not require that fair value always be a predetermined point in the bid-ask range. The Company’s policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that results in the Company’s best estimate of fair value.

Fair value for certain of the Company’s Level 3 financial instruments is derived using internal valuation models. These internal valuation models include discounted cash flow analyses developed by management using current interest rates, estimates of the term of the particular contract, specific issuer information and other market data for securities without an active market. In accordance with SFAS No. 157, the impact of the Company’s own credit and creditworthiness of consolidated CDOs is also considered when measuring the fair value of liabilities, including derivative contracts. Where appropriate, valuation adjustments are made to account for various factors, including bid-ask spreads, credit quality and market liquidity. These adjustments are applied on a consistent basis and are based upon observable inputs where available. Management’s estimate of fair value requires significant management judgment and is subject to a high degree of variability based upon market conditions, the availability of specific issuer information and management’s assumptions.

Financial instruments that are generally classified in Level 3 of the fair value hierarchy primarily consist of investments in TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable. The valuation techniques used for those financial instruments classified in Level 3 are described below.

TruPS and TruPS Security-Related Receivables: The fair value of investments in TruPS is estimated using internal valuation models. These investment securities generally do not trade in an active market and, therefore observable price quotations are not available. In the absence of observable price quotations, fair value is determined based on discounted cash flow models using current interest rates, estimates of the term of the particular contract, specific issuer information, including estimates of comparable market credit spreads and other market data.

MBS: The fair value of investments in MBS is determined based on external price and spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable bonds.

CDO Notes Payable: The fair value of CDO notes payable liabilities is estimated using external price data (where observable), or internal valuation models. In the absence of observable price quotations, fair value is determined based on prices of comparable notes payable, or discounted cash flow models using current interest rates, estimates of the term of the particular contract, specific underlying collateral information, including estimates of credit spreads and other market data for securities without an active market.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 provides entities with an irrevocable option to report most financial assets and liabilities at fair value, with subsequent changes in fair value reported in earnings. The election can be applied on an instrument-by-instrument basis. SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities, and became effective for the Company on January 1, 2008. The Company elected to apply the fair value option for its investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and TruPS obligations. The Company has elected the fair value option for these instruments to enhance the transparency of its financial condition. The transition adjustment to beginning accumulated deficit that was recorded as of January 1, 2008 due to the adoption of SFAS No. 159 was an increase to accumulated deficit of $1.1 billion. The following table presents information about the eligible instruments for which the Company elected the fair value option and for which transition adjustments were recorded as of January 1, 2008 (amounts in thousands):


Financial Instrument Description	Carrying Value at January 1, 2008 (Before Adoption of SFAS No. 159)		Transition Adjustment to Accumulated Deficit Increase/(Decrease)			Carrying Value at January 1, 2008 (After Adoption of SFAS No. 159)
Assets:
TruPS and subordinated debentures	$	3,793,930	$	(924,053	)(1)	$	3,793,930
TruPS security-related receivables		740,342		(113,123	)		627,219
MBS		2,091,007		(554,171	)(1)		2,091,007
Liabilities:
TruPS CDO notes payable		4,924,033		838,109	(2)		4,085,924
MBS CDO notes payable		3,852,837		1,804,175	(3)		2,048,662
TruPS obligations		382,600		79,005			303,595

Cumulative effect of the adoption				1,129,942
Minority interest allocation of cumulative adjustment				(22,737	)

Cumulative effect of the adoption to accumulated deficit(4)				1,107,205
Adjustments related to other comprehensive income				1,478,224

Cumulative effect of the adoption to stockholders’ equity			$	2,585,429

(1)

Prior to January 1, 2008, TruPS and subordinated debentures and MBS were classified as available-for-sale and carried at fair value. Accordingly, the election of the fair value option for these securities did not change their carrying value and resulted in a reclassification from accumulated other comprehensive loss to beginning accumulated deficit.

(2)	Includes write-off of deferred issuance costs of $76.9 million.

(3)	Includes write-off of deferred issuance costs of $21.0 million.

(4)	Amount includes $1.9 million of a deferred tax asset recorded upon adoption of SFAS No. 159.

Investments

The Company invests primarily in TruPS and MBS debt securities, residential and commercial mortgage portfolios, and leveraged loans and may invest in other types of real estate-related assets. The Company accounts for its investments in debt securities under Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” as amended and interpreted (“SFAS No. 115”), and designates each investment as a trading security, an available-for-sale security, or a held-to-maturity security based on management’s intent at the time of acquisition. Under SFAS No. 115, trading securities are recorded at their fair value each reporting period with fluctuations in fair value reported as a component of earnings. Available-for-sale securities are recorded at fair value with changes in fair value reported as a component of other comprehensive income (loss). Fair value of investments is based on quoted market prices from independent pricing sources, or when quoted market prices are not available because certain securities do not actively trade in the public markets, based on comparisons to similar instruments or from internal pricing models. These internal valuation models include discounted cash flow analyses developed by management using current interest rates, estimates of the term of the particular contract, specific issuer information and other market data for securities without an active market. Management’s estimate of fair value requires significant management judgment and is subject to a high degree of variability based upon market conditions, the availability of specific issuer information and management’s assumptions. Upon the sale of a security, the realized gain or loss is computed on a specific identification basis and is recorded as a component of earnings in the respective period.

Effective January 1, 2008, the Company classifies its investments in TruPS and MBS as trading securities (see “Fair Value of Financial Instruments”). These investments are carried at estimated fair value, with changes in fair value of these instruments reported in income. Unamortized premiums and discounts on trading securities that are highly rated are recognized over the contractual life, adjusted for estimated prepayments using the effective interest method. For securities representing beneficial interests in securitizations that are not highly rated (i.e., subordinate tranches of MBS), unamortized premiums and discounts are recognized over the contractual life, adjusted for estimated prepayments and estimated credit losses of the securities using the effective interest method. Actual prepayment and credit loss experience are reviewed quarterly and effective yields are recalculated when differences arise between prepayments and credit losses originally anticipated compared to amounts actually received plus anticipated future prepayments.

Effective January 1, 2008, the Company accounts for its investments in subordinated debentures owned by Trust VIEs that the Company consolidates at fair value. These Trust VIEs have no ability to sell, pledge, transfer or otherwise encumber a company or the assets of a company until such subordinated debenture’s maturity. The Company accounts for investments in securities where the transfer meets the criteria as a secured financing under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”) as secured loans at fair value. The Company’s investments in security-related receivables represent interests in securities that were transferred to CDO securitization entities by transferors that maintain some level of continuing involvement.

As it relates to available-for-sale securities, the Company exercises judgment to determine whether an investment security has sustained an other-than-temporary decline in fair value. If the Company determines that an investment security has sustained an other-than-temporary decline in its fair value, the investment security is written down to its fair value by a charge to earnings, and the Company establishes a new cost basis for the investment. The Company’s evaluation of an other-than-temporary decline is dependent on specific facts and circumstances relating to the particular investment. Factors that the Company considers in determining whether an other-than-temporary decline in fair value has occurred include, but are not limited to: the estimated fair value of the investment in relation to its cost basis; the length of time the security has had a decline in estimated fair value below its amortized cost; the financial condition of the related entity and industry events; changes in estimated cash flows from the investment; external credit ratings and recent downgrades of such credit ratings; and the intent and ability of the Company to hold the investment for a sufficient period of time to allow for recovery in the fair value of the investment. For MBS that are not of high credit quality at acquisition, the Company performs impairment analyses in accordance with Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF No. 99-20”). When adverse changes in estimated cash flows occur as a result of actual or expected prepayment and credit loss experience, an other-than-temporary impairment is deemed to have occurred. Accordingly, the security is written down to fair value, and the loss is recognized in current earnings. The cost basis adjustment for other-than-temporary impairment is recoverable only upon sale or maturity of the security. Effective January 1, 2008, the Company is not classifying any of its investments as available-for-sale.

The Company accounts for its investments in residential and commercial mortgages and leveraged loans at amortized cost. The carrying value of these investments is adjusted for origination discounts/premiums, nonrefundable fees and direct costs for originating loans which are amortized into income over the terms of the loans using the effective yield method adjusted for the effects of estimated prepayments based on Statement of Financial Accounting Standards No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases” (“SFAS No. 91”).

The Company maintains an allowance for residential and commercial mortgages and leveraged loan losses based on management’s evaluation of known losses and inherent risks in the portfolios, including historical and industry loss experience, economic conditions and trends, estimated fair values, the quality of collateral and other relevant quantitative and qualitative factors. Specific allowances for losses may be established for potentially impaired loans based on a comparison of the recorded carrying value of the loan to either the present value of the loan’s expected cash flow, the loan’s estimated market price or the estimated fair value of the underlying collateral. The allowance is increased by charges to operations and decreased by charge-offs (net of recoveries).

An impaired loan may be left on accrual status during the period the Company is pursuing repayment of the loan; however, the loan is placed on non-accrual status at such time as the Company believes that scheduled debt service payments may not be paid when contractually due or the loan becomes 90 days delinquent. While on non-accrual status, interest income is recognized only upon actual receipt.

Transfers of Financial Assets

The Company accounts for transfers of financial assets under SFAS No. 140 as either sales or financing arrangements. Transfers of financial assets that result in sale accounting are those in which (a) the transfer legally isolates the transferred assets from the transferor, (b) the transferee has the right to pledge or exchange the transferred assets and no condition both constrains the transferee’s right to pledge or exchange the assets and provides more than a trivial benefit to the transferor, and (c) the transferor does not maintain effective control over the transferred assets. If the transfer does not meet each of these criteria, the transfer is accounted for as a financing arrangement. Dispositions of financial assets that are treated as sales are removed from the Company’s accounts with any realized gain (loss) reflected in earnings during the period of sale. Dispositions of financial assets that are treated as financings are maintained on the balance sheet with proceeds received from the legal transfer reflected as secured borrowings and no gain or loss is recognized.

Revenue Recognition

The Company recognizes interest income from investments in debt and other securities, residential and commercial mortgages, and leveraged loans over the estimated life of the underlying financial instruments on an estimated yield to maturity basis.

In accordance with EITF No. 99-20, the Company recognizes interest income from purchased interests in certain financial assets, including certain subordinated MBS, on an estimated effective yield to maturity basis. Management estimates the current yield on the reference amount of the investment based on estimated cash flows after considering prepayment and credit loss expectations. The adjusted yield is then applied prospectively to recognize interest income for the next reporting period.

Derivative Instruments

The Company uses derivative financial instruments to attempt to hedge all or a portion of the interest rate risk associated with its borrowings. In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted (“SFAS No. 133”), the Company measures each derivative instrument (including certain derivative instruments embedded in other contracts) at fair value and records such amounts in its consolidated balance sheet as either an asset or liability. Derivatives qualifying and designated as cash-flow hedges are evaluated at inception and at subsequent balance sheet dates in order to determine whether they qualify for hedge accounting under SFAS No. 133. The hedge instrument must be highly effective in achieving offsetting changes in cash flows of the hedged item attributable to the risk being hedged in order to qualify for hedge accounting. Derivative contracts are carried on the consolidated balance sheet at fair value. For derivatives designated as cash flow hedges, the effective portions of changes in the fair value of the derivative are reported in other comprehensive income (loss). Changes in the ineffective portions of cash flow hedges are recognized in earnings. Realized gains and losses on terminated contracts that were designated as hedges are maintained in accumulated other comprehensive income or loss and amortized into interest expense over the contractual life of the terminated contract unless it is probable that the forecasted transaction will not occur. In that case, the gain or loss in accumulated other comprehensive income or loss is reclassified to realized gain or loss in the consolidated statement of income.

The Company may also enter into derivatives that do not qualify for hedge accounting or for which the Company may not elect hedge accounting, including interest rate swaps, interest rate caps and floors, credit default and total return swaps, under SFAS No. 133. These derivatives are carried at their fair value with changes in fair value reflected in the consolidated statement of income. The fair value of credit default swaps is based on quotations from third-party brokers.

Accounting for Off-Balance Sheet Arrangements

The Company may maintain certain warehouse financing arrangements with various investment banks that are accounted for as off-balance sheet arrangements. The Company receives the difference between the interest earned on the investments under the warehouse facilities and the interest charged by the warehouse providers from the dates on which the respective investments were acquired. Under the warehouse agreements, the Company is typically required to deposit cash collateral with the warehouse provider and as a result, the Company bears the first dollar risk of loss, up to the warehouse deposit, if (i) an investment funded through the warehouse facility becomes impaired or (ii) a CDO is not completed by the end of the warehouse period, and in either case, the warehouse provider is required to liquidate the securities at a loss. These off-balance sheet arrangements are not consolidated because the collateral assets are maintained on the balance sheet of the warehouse providers. However, since the Company holds an implicit variable interest in many entities funded under its TruPS-related warehouse facilities, the Company often does consolidate the Trust VIEs while the TruPS they issue are held on the warehouse facilities. The Company records the cash collateral as warehouse deposits in its financial statements. The net amount earned from these warehouse facilities and any obligation associated with the warehouse arrangement are considered free-standing derivatives and are recorded at fair value in the financial statements with changes in fair value reflected in earnings in the respective period.

Income Taxes

For tax purposes, Sunset is deemed to have acquired Alesco Financial Trust on October 6, 2006. Sunset elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code and subsequent to the merger the Company continues to comply with these requirements. Accordingly, the Company generally will not be subject to U.S. federal income tax to the extent of its distributions to stockholders and as long as certain asset, income, distribution and share ownership tests are met. If the Company were to fail to meet these requirements, it would be subject to U.S. federal income tax, which could have a material adverse impact on its results of operations and amounts available for distributions to its stockholders. Management believes that all of the criteria to maintain the Company’s REIT qualification have been met for the applicable periods, but there can be no assurances that these criteria will continue to be met in subsequent periods.

The Company maintains domestic Taxable REIT Subsidiaries (“TRSs”), which may be subject to U.S. federal, state and local income taxes. Current and deferred taxes are provided for on the portion of earnings (losses) recognized by the Company with respect to its interest in domestic TRSs. Deferred income tax assets and liabilities are computed based on temporary differences between the GAAP consolidated financial statements and the federal and state income tax basis of assets and liabilities as of the consolidated balance sheet date. We evaluate the realizability of our deferred tax assets and recognize a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of our deferred tax assets will not be realized. When evaluating the realizability of our deferred tax assets, we consider estimates of expected future taxable income, existing and projected book/tax differences, tax planning strategies available, and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires management to forecast our business and general economic environment in future periods. Changes in estimate of deferred tax asset realizability, if any, are included in income tax expense on the consolidated statements of income.

Certain TRS entities are domiciled in the Cayman Islands and, accordingly, taxable income generated by these entities may not be subject to local income taxation, but generally will be included in the Company’s income on a current basis, whether or not distributed. Upon distribution of any previously included income to the Company, no incremental U.S. federal, state, or local income taxes would be payable by the Company.

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”). SFAS No. 160 requires reporting entities to present noncontrolling (minority) interests as equity (as opposed to as a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. SFAS No. 160 applies prospectively as of December 1, 2009, except for the presentation and disclosure requirements which will be applied retrospectively for all periods presented. Management is currently evaluating the impact that this statement may have on our consolidated financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133” (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosure related to derivatives and hedging activities and thereby seeks to improve the transparency of financial reporting. Under SFAS No. 161, entities are required to provide enhanced disclosures relating to: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The statement is effective for fiscal years beginning after November 15, 2008. Management is currently evaluating the impact that this statement may have on our consolidated financial statements.

In April 2007, the FASB issued FASB Staff Position (“FSP”) No. FIN 39-1, “Amendment of FASB Interpretation No. 39”, (“FSP FIN 39-1”). FSP FIN 39-1 amends certain provisions of FIN 39, “Offsetting of Amounts Related to Certain Contracts,” and permits companies to offset fair value amounts recognized for cash collateral receivables or payables against fair value amounts recognized for net derivative positions, including credit default swaps, executed with the same counterparty under the same master netting arrangement.

NOTE 3: FAIR VALUE OF FINANCIAL INSTRUMENTS

Effective January 1, 2008, the Company adopted SFAS No. 157, which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value. The following table presents information about the Company’s assets and liabilities (including derivatives that are presented net) measured at fair value on a recurring basis as of June 30, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.


	Assets and Liabilities at Fair Value as of June 30, 2008
(amounts in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment in TruPS and TruPS security-related receivables	$	—	$	—	$	3,245,259	$	3,245,259
MBS		—		—		925,223		925,223
Other investments		—		—		1,654		1,654

Total Assets		—		—		4,172,136		4,172,136
Liabilities:
TruPS CDO notes payable	$	—	$	—	$	2,827,568	$	2,827,568
MBS CDO notes payable		—		—		883,178		883,178
TruPS obligations		—		—		222,343		222,343
Interest rate swap liabilities		—		103,757		—		103,757

Total Liabilities		—	$	103,757	$	3,933,089	$	4,036,846

The tables presented below summarize the change in asset and liability carrying values associated with Level III financial instruments during the six-month period ending June 30, 2008 (amounts in thousands):


Assets	Investment in TruPS and TruPS Security-Related Receivables			MBS			Other Investments			Total
Balance at January 1, 2008	$	4,421,149		$	2,091,007		$	3,712		$	6,515,868
Net payments, purchases and sales		(10,347	)		(320,255	)		(695	)		(331,297	)
Net transfers in/(out)		—			—			—			—
Gains/(losses) recorded in income		(1,165,543	)		(845,529	)		(1,363	)		(2,012,435	)

Balance at June 30, 2008	$	3,245,259		$	925,223		$	1,654		$	4,172,136


Liabilities	TruPS CDO Notes Payable			MBS CDO Notes Payable			TruPS Obligations			Total
Balance at January 1, 2008	$	4,009,015		$	2,027,682		$	303,595		$	6,340,292
Net Payments, purchases and sales		(10,529	)		(309,780	)		—			(323,116	)
Net Transfers In/(Out)		—			—			—			—
(Gains)/Losses Recorded in income		(1,170,918	)		(829,110	)		(81,252	)		(2,084,087	)

Balance at June 30, 2008	$	2,827,568		$	883,178		$	222,343		$	3,933,089

NOTE 4: INVESTMENTS IN DEBT SECURITIES

The following table summarizes the Company’s investments in debt securities and security-related receivables as of June 30, 2008:


Investment Description	Amortized Cost		Net Change in Fair Value			Estimated Fair Value		Weighted Average Coupon		Weighted- Average Years to Maturity
Investments in TruPS and subordinated debentures and security-related receivables	$	5,535,368	$	(2,290,109	)	$	3,245,259	5.5	%	27.8
MBS		2,063,532		(1,138,309	)		925,223	3.7	%	6.4
Other investments		1,654		—			1,654	—		7.1

Total	$	7,600,554	$	(3,428,418	)	$	4,172,136	5.0	%	22.0

TruPS shown above include (a) investments in TruPS issued by Trust VIEs of which the Company is not the primary beneficiary and which the Company does not consolidate and (b) transfer of investments in TruPS to the Company that were accounted for as a sale pursuant to SFAS No. 140. Subordinated debentures included above represents the primary assets of Trust VIEs that the Company consolidates pursuant to FIN 46R.

The Company’s investments in security-related receivables represent securities owned by CDO entities that are collateralized by TruPS and subordinated debentures owned by a consolidated subsidiary where the transfers are accounted for as financings under SFAS No. 140. These transactions are accounted for as financings due to certain constraints that limit further pledging or exchanging of the assets and the continuing involvement of investment banks with each of these transactions. As of June 30, 2008, the Company’s consolidated financial statements included $505.1 million of security-related receivables held at fair value.

As of June 30, 2008, the aggregate principal amount of investments in the eleven TruPS investments that are defaulted or are currently deferring interest payments is $282.3 million, representing approximately 5.5% of the Company’s combined TruPS portfolio. As of June 30, 2008, the $145 million of defaulted securities, which includes securities issued by IndyMac Bancorp, have been completely written off in the Company’s consolidated financial statements. For the three-months ended June 30, 2008, investment interest income is net of a $4.4 million reserve for interest income related to $245.5 million of the currently deferring or defaulted securities.

The TruPS deferrals and defaults described above have resulted in the over-collateralization tests being triggered in seven of the eight CDOs in which the Company holds equity interests. One of the CDO over-collateralization failures has since been cured, bringing the total number of TruPS CDOs in over-collateralization failure status to six as of June 30, 2008. The trigger of an over-collateralization test in a TruPS CDO means that the Company, as a holder of equity securities, will no longer receive current distributions of cash in respect of its equity interests until sufficient cash or collateral is retained in the CDOs to cure the over-collateralization tests. The Company currently projects that three of the six affected CDOs may cure the over-collateralization failures and recommence making equity distributions within 3 to 6 quarters and the other three may do so within 20 to 35 quarters. These cash flow projections assume zero recovery of principal or interest on any of the currently deferring or defaulted securities and no additional deferrals. There can be no assurance that we will not experience additional deferrals or defaults that will result in further over-collateralization test failures or extend the expected cure periods of the deals currently failing over-collateralization tests.

The following table summarizes ratings of the MBS investments held by consolidated Kleros Real Estate CDOs (categorized based on fair value as of June 30, 2008 as rated by Standard & Poor’s (“S&P”) as of July 2008):


S&P Rating Category	Total MBS per Rating Category		% of Total MBS per Rating Category		Amount of Subprime per Rating Category (1)		% of Subprime per Rating Category		Amount of Second- Lien per Rating Category		% of Second- Lien per Rating Category
	(dollars in thousands)
AAA	$	477,062	51.5	%	$	6,829	4.4	%	$	—	0.0	%
AA+		119,407	12.9	%		46,310	29.4	%		264	6.3	%
AA		122,689	13.3	%		15,153	9.7	%		89	2.1	%
AA–		32,405	3.5	%		7,351	4.7	%		29	0.7	%
A+		38,245	4.1	%		12,538	8.0	%		430	10.2	%
A		34,034	3.7	%		14,390	9.2	%		—	0.0	%
A–		1,615	0.2	%		575	0.4	%		85	2.0	%
BBB+		1,334	0.1	%		963	0.6	%		22	0.5	%
BBB		14,511	1.6	%		5,270	3.4	%		807	19.1	%
BBB–		814	0.1	%		—	0.0	%		813	19.3	%
BB+ and below		83,107	9.0	%		47,519	30.2	%		1,684	39.8	%

Total	$	925,223	100.0	%	$	156,898	100.0	%	$	4,223	100.0	%

(1)	We generally consider a loan to a borrower with a FICO score of less than 625 to be a subprime loan.

As previously disclosed, the Kleros Real Estate CDOs have all failed over-collateralization tests as a result of significant ratings agency downgrade activity and are no longer making cash distributions to the Company. The net cash flows of the Kleros Real Estate CDOs are currently being used to pay down the controlling class debtholders in each of the Kleros Real Estate CDOs. Despite the fact that each Kleros Real Estate CDO has failed over-collateralization tests, the net interest earnings of these CDOs continues to be reflected in the Company’s net investment income and taxable income. In addition, we received written notice from the trustees of Kleros Real Estate I, II, and III that each CDO has experienced an event of default. These events of default resulted from the failure of certain additional over-collateralization tests primarily due to credit rating agency downgrades. The events of default provide the controlling class debtholder in each CDO with the option to liquidate all of the MBS assets collateralizing the particular CDO. The proceeds of any such liquidation would be used to repay the controlling class debtholder.

On May 1, 2008, the Company received written notice from the trustee of Kleros Real Estate III that the controlling class debtholder has submitted a notice of liquidation. The liquidation of Kleros Real Estate III occurred in June 2008 through a series of auctions of the underlying collateral and the final distribution of the liquidation proceeds was delivered to the controlling class debtholder in the same period. Upon the commencement of the liquidation process the Company determined that it was no longer the primary beneficiary of Kleros Real Estate III, and in accordance with FIN 46(R) deconsolidated the Kleros Real Estate III entity from its consolidated financial statements in June 2008.

As of the current date, the controlling class debtholders of Kleros Real Estate I and II have not exercised their rights to liquidate either CDO. Since the Company is not receiving any cash flow from its investments in any of the Kleros Real Estate CDOs, the events of default and liquidation described above do not have any further impact on the Company’s cash flows. However, the assets of the Kleros Real Estate I and II CDOs and the income they generate for tax purposes are a component of the Company’s REIT qualifying assets and income. If more than one of the three remaining Kleros Real Estate CDOs is liquidated, the Company may have to deploy additional capital into REIT qualifying assets in order to continue to qualify as a REIT. If the Company is not able to invest in sufficient other REIT qualifying assets, its ability to qualify as a REIT could be materially adversely affected.

Substantially all of the Company’s investments in TruPS, subordinated debentures and MBS collateralize debt issued through consolidated CDO entities, consolidated Trust VIEs, or warehouse credit facilities. Consolidated CDO entities are generally subject to an indenture which dictates substantially all of the operating activities of the CDO. These indentures generally require that certain credit quality and over-collateralization tests are met. To the extent a CDO fails to pass such tests, cash flows from the assets may be directed to be used to repay the CDO debt obligations. The assets of the Company’s consolidated CDOs collateralize the debt of such entities and are not available to the Company’s general creditors. Similarly, the debt of such entities is not recourse to the Company.

NOTE 5: LOANS

The Company’s investments in loans are accounted for at amortized cost. The following table summarizes the Company’s investments in loans as of June 30, 2008:


	Unpaid Principal Balance		Unamortized Premium/ (Discount)			Carrying Amount		Number of Loans	Weighted- Average Interest Rate		Weighted- Average Contractual Maturity Date
	(dollars in thousands)
⁵/1 Adjustable rate residential mortgages	$	648,471	$	5,885		$	654,356	1,570	6.3	%	July 2036
⁷/1 Adjustable rate residential mortgages		229,332		3,199			232,531	525	6.6	%	Dec 2036
¹⁰/1 Adjustable rate residential mortgages		74,018		1,237			75,255	195	6.8	%	Sept 2036
Commercial loan (1)		7,464		—			7,464	1	21.0	%	—
Leveraged loans		857,522		(4,487	)		853,035	410	6.7	%	Apr 2013

Total	$	1,816,807	$	5,834		$	1,822,641	2,701	6.5	%

(1)	Weighted-average interest rate excludes non-interest accruing commercial loan.

The Company maintains an allowance for loan losses based on management’s evaluation of known losses and inherent risks in the portfolios, which considers historical and industry loss experience, economic conditions and trends, estimated fair values and the quality of collateral and other relevant quantitative and qualitative factors. Specific allowances for losses are established for potentially impaired loans based on a comparison of the recorded carrying value of the loan to either the present value of the loan’s expected cash flow, the loan’s estimated market price or the estimated fair value of the underlying collateral. The allowance is increased by charges to operations and decreased by charge-offs (net of recoveries). As of June 30, 2008, the Company maintained an allowance for loan losses of $33.5 million. As of June 30, 2008, the Company has placed $33.8 million of residential mortgage loans on non-accrual status.

The following table summarizes the delinquency statistics of the Company’s residential mortgage loans as of June 30, 2008 (dollar amounts in thousands):


Delinquency Status	Number of Loans	Principal Amount
30 to 59 days	69	$	27,652
60 to 89 days	27		10,111
90 days or more	149		58,212

Total	245	$	95,975

During the three and six-month period ended June 30, 2008, the Company foreclosed on 15 and 30 residential mortgage loans with fair values of $1.7 million and $6.8 million, respectively, which are classified as real estate owned (REO). The Company records REO property at fair value within other assets in its consolidated balance sheet. During the three and six-month period ended June 30, 2008, the Company recorded charge-offs of $3.7 million and $5.9 million, respectively, as a result of foreclosing on these properties. As of June 30, 2008, the Company had $11.7 million of REO property recorded within other assets in the consolidated financial statements.

As of June 30, 2008, approximately $962.1 million of the carrying value of the Company’s residential mortgages was pledged as collateral for securitized mortgage debt. In addition, substantially all of the carrying value of the Company’s leveraged loan portfolio is pledged as collateral for CLO notes payable.

As of June 30, 2008, 46.9% of the carrying value of the Company’s residential mortgages were concentrated in residential mortgages collateralized by property in California.

NOTE 6: INDEBTEDNESS

The following table summarizes the Company’s total indebtedness as of June 30, 2008 (includes recourse and non-recourse indebtedness):


Description	Amortized Cost		Net Change in Fair Value			Carrying Amount		Interest Rate Terms	Current Weighted- Average Interest Rate		Weighted- Average Contractual Maturity
Non-recourse indebtedness:
Trust preferred obligations	$	382,600	$	(160,257	)	$	222,343	4.3% to 8.7%	5.7	%	Oct 2036
Securitized mortgage debt		888,920		—			888,920	5.0% to 6.0%	5.7	%	Mar 2017
CDO notes payable (1)		8,471,370		(4,080,294	)		4,391,076	2.6% to 7.9%	3.2	%	Apr 2039
Warehouse credit facilities		130,687		—			130,687	3.9%	3.9	%	May 2009

Total non-recourse indebtedness	$	9,873,577	$	(4,240,551	)	$	5,633,026

Recourse indebtedness:
Junior subordinated debentures	$	49,614		—		$	49,614	7.0% to 9.5%	8.4	%	Sept 2038
Contingent convertible debt		140,000		—			140,000	7.6%	7.6	%	May 2027

Total recourse indebtedness	$	189,614		—		$	189,614

Total indebtedness	$	10,063,191	$	(4,240,551	)	$	5,822,640

(1)	Excludes CDO notes payable purchased by the Company which are eliminated in consolidation. Carrying amount includes $3,710,746 of liabilities at fair value.

Recourse indebtedness refers to indebtedness that is recourse to the general assets of the Company. As indicated in the table above, the Company’s consolidated financial statements include recourse indebtedness of $189.6 million as of June 30, 2008. Non-recourse indebtedness consists of indebtedness of consolidated VIEs (i.e. CDOs, CLOs and other securitization vehicles) which is recourse only to specific assets pledged as collateral to the lenders. The creditors of each consolidated VIE have no recourse to the general credit of the Company. As of June 30, 2008, the Company’s maximum exposure to economic loss as a result of its involvement with each VIE is the $461.8 million of capital that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other types of securitization structures. None of the indebtedness shown in the table above subjects the Company to potential margin calls for additional pledges of cash or other assets.

(a)

Repurchase agreements

As of June 30, 2008, the Company is not financing any investments with short-term repurchase agreements that subject the Company to margin calls or potential recourse obligations in excess of posted first loss deposits.

(b)

Trust preferred obligations

Trust preferred obligations finance subordinated debentures acquired by Trust VIEs that are consolidated by the Company for the portion of the total TruPS that are owned by entities outside of the consolidated group. These trust preferred obligations bear interest at either variable or fixed rates until maturity, generally 30 years from the date of issuance. The Trust VIE has the ability to prepay the trust preferred obligation at any time, without prepayment penalty, after five years. The Company does not control the timing or ultimate payment of the trust preferred obligations. Effective January 1, 2008, the Company has elected the fair value option pursuant to SFAS No. 159 for trust preferred obligations.

(c) CDO notes payable

CDO notes payable represent notes payable issued by CDO entities used to finance the acquisition of TruPS, MBS, and leveraged loans. Substantially all of the TruPS collateralizing CDO notes payable are obligations of banks, bank holding companies and insurance companies. The obligors under the leveraged loans come from a variety of industries. Generally, CDO notes payable are comprised of various classes of notes payable, with each class bearing interest at variable or fixed rates. Effective January 1, 2008, the Company has elected the fair value option pursuant to SFAS No. 159 for TruPS and MBS CDO notes payable.

(d) Warehouse Credit Facilities

As of June 30, 2008, the Company’s consolidated financial statements included $130.7 million of warehouse credit facility debt in the form of short term notes payable. Warehouse credit facility debt relates to on-balance sheet warehouse facilities entered into by a subsidiary of the Company utilized to finance the acquisition of leveraged loans on a short-term basis until CDO notes payable are issued to finance the investments on a longer-term basis. The Company’s maximum economic exposure to loss on the warehouse credit facility is limited to the amount of capital that the Company has invested pursuant to the terms of the arrangement. As of June 30, 2008, the Company has invested $40.1 million of capital in this financing arrangement, which provides for $200 million of total borrowing capacity and bears interest of 125 basis points over the daily commercial paper rate and matures in May 2009.

NOTE 7: DERIVATIVE FINANCIAL INSTRUMENTS

The Company may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with its borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company’s operating and financial structure as well as to hedge specific anticipated transactions. The counterparties to these contractual arrangements are major financial institutions with which the Company and its affiliates may also have other financial relationships. In the event of nonperformance by the counterparties, the Company is potentially exposed to credit loss. However, because of the high credit ratings of the counterparties, the Company does not anticipate that any of the counterparties will fail to meet their obligations.

The table below summarizes the aggregate notional amount and estimated net fair value of the Company’s derivative instruments which are included in other assets and other liabilities (amounts in thousands):


	As of June 30, 2008
	Notional		Net Fair Value
Interest Rate Related:
Interest rate swaps	$	1,815,359	$	(104,172	)
Basis swaps		385,000		415
Credit default swaps		—		—

Net fair value	$	2,200,359	$	(103,757	)

The following table summarizes by derivative instrument type the effect on income for the following periods (amounts in thousands):


	For the six-month period ended June 30, 2008						For the six-month period ended June 30, 2007
Type of Derivative	Amounts Reclassified to Earnings for Effective Hedges – Gains (Losses)			Amounts Reclassified to Earnings for Hedge Ineffectiveness & Non-Hedged Derivatives – Gains (Losses)			Amounts Reclassified to Earnings for Effective Hedges – Gains (Losses)		Amounts Reclassified to Earnings for Hedge Ineffectiveness & Non-Hedged Derivatives – Gains (Losses)
Interest rate swaps	$	(4,041	)	$	(58,917	)	$	3,521	$	2,621
Basis swaps		—			35			—		(152	)
Warehouse financing arrangements		—			—			—		1,766
Credit default swaps		—			17,115			—		11,836

Net realized and unrealized gains (losses) on derivatives	$	(4,041	)	$	(41,767	)	$	3,521	$	16,071


	For the three-month period ended June 30, 2008						For the three-month period ended June 30, 2007
Type of Derivative	Amounts Reclassified to Earnings for Effective Hedges – Gains (Losses)			Amounts Reclassified to Earnings for Hedge Ineffectiveness & Non-Hedged Derivatives – Gains (Losses)			Amounts Reclassified to Earnings for Effective Hedges – Gains (Losses)		Amounts Reclassified to Earnings for Hedge Ineffectiveness & Non-Hedged Derivatives – Gains (Losses)
Interest rate swaps	$	(1,458	)	$	32,494		$	—	$	4,500
Basis swaps		—			(205	)		—		(146	)
Warehouse financing arrangements		—			—			—		1,049
Credit default swaps		—			6,224			—		11,836

Net realized and unrealized gains (losses) on derivatives	$	(1,458	)	$	38,513		$	—	$	17,239

The gains recorded in 2008 as described in the tables above were offset by the reclassification to the income statement of $40.6 million of cash flow hedge losses that were previously recorded in accumulated other comprehensive loss. The reclassifications resulted from the Company’s determination that the forecasted transactions that the instruments hedge are no longer probable of occurring due to the likelihood of or actual liquidation of our Kleros Real Estate I, II and III portfolios.

Cash Flow Hedges

The Company enters into various interest rate swap contracts to hedge interest rate exposure relating to CDO notes payable and warehouse credit facilities that are used to finance investments in our target asset classes.

Generally, the Company designates interest rate swap contracts as cash flow hedges at inception and determines at each reporting period whether or not the interest rate swap contracts are highly effective in offsetting interest rate fluctuations associated with the identified indebtedness. Certain of the Company’s interest rate swap contracts were not designated as interest rate hedges at inception, therefore the change in fair value during the period in which the interest rate swap contracts were not designated as hedges was recorded as an unrealized gain (loss) on interest rate swap contracts in the consolidated statements of income (loss). Effective January 1, 2008, we adopted the fair value option under SFAS No. 159 for our TruPS and MBS CDO notes payable and therefore, have discontinued hedge accounting for all of the interest rate swaps associated with those transactions.

Credit Default Swaps

During June 2008, the Company sold the subsidiary that owned $87.5 million notional of CDS positions for $70.4 million in proceeds (inclusive of the $69.3 million of counterparty margin held as of March 31, 2008). During the three-month period ended June 30, 2008, the Company recorded a net loss upon disposition of the consolidated subsidiary of $5.6 million, which was offset by approximately $6.2 million of unrealized gains on CDS recorded during the same period. The Company records both realized and unrealized changes in fair value on the CDS contracts within net change in fair value of derivative contracts in the consolidated statements of income (loss). Following the June 2008 sale, the Company no longer holds any investments in CDS.

NOTE 8: EARNINGS (LOSS) PER SHARE

The following table presents a reconciliation of basic and diluted earnings per share for the following periods (dollars in thousands, except per share data):


	For the three months ended June 30, 2008		For the three months ended June 30, 2007		For the six months ended June 30, 2008		For the six months ended June 30, 2007
Net income (loss)	$	(81,204)		$ (47,217)	$	3,683	$	(35,439)

Weighted-average common shares outstanding—Basic		59,512,594		54,902,323		59,422,581		54,800,726
Unvested restricted common shares under the treasury stock method		—		—		212,824		—

Weighted-average shares outstanding—Diluted		59,512,594		54,902,323		59,635,405		54,800,726

Earnings (loss) per share—Basic	$	(1.36)	$	(0.86)	$	0.06	$	(0.65)

Earnings (loss) per share—Diluted	$	(1.36)	$	(0.86)	$	0.06	$	(0.65)

Anti-dilutive shares		356,973		575,956		—		853,160

Shares of vested restricted common stock are included in basic weighted-average common shares and shares of unvested restricted common stock are included in the diluted weighted-average shares under the treasury stock method, unless anti-dilutive.

NOTE 9: MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS

The Company’s Chairman of the Board and other officers serve as executive officers of Cohen & Company, of which the manager is an affiliate. The manager handles the Company’s day-to-day operations, provides the Company with office facilities, and administers the Company’s business activities through the resources of Cohen & Company. The management agreement was executed on January 31, 2006 between the manager and Alesco Financial Trust and, upon the closing of the merger on October 6, 2006, the Company assumed the management agreement. The initial term expires on December 31, 2008 and shall be automatically renewed for a one-year term on each anniversary date thereafter unless two-thirds of the independent directors or the holders of at least a majority of the outstanding shares of common stock vote not to automatically renew the management agreement.

The management agreement provides, among other things, that in exchange for managing the day-to-day operations and administering the business activities of the Company, the manager is entitled to receive from the Company certain fees and reimbursements, consisting of a base management fee, an incentive fee based on certain performance criteria, reimbursement for certain operating expenses as defined in the management agreement, and a termination fee if the Company decides to terminate the management agreement without cause or if the manager terminates the management agreement due to the Company’s default. The base management fee and the incentive fee otherwise payable by the Company to the manager pursuant to the management agreement are reduced by the Company’s proportionate share of the amount of any CDO and CLO collateral management fees that are paid to Cohen & Company and its affiliates in connection with the CDOs and CLOs in which the Company invests, based on the percentage of equity it holds in such CDOs and CLOs.

During both the three-month period ended June 30, 2008 and 2007, the Company incurred base and incentive management fees, net of asset management fee credits, of $0. The Company recognized stock-based compensation expense of $0.4 million and $0.7 million related to restricted common stock granted to the officers of the Company and key employees of the manager and Cohen & Company during the three-month period ended June 30, 2008 and 2007, respectively.

During both the six-month period ended June 30, 2008 and 2007, the Company incurred base and incentive management fees, net of asset management fee credits of $0. The Company recognized stock-based compensation expense of $0.8 million and $1.0 million related to restricted common stock granted to the officers of the Company and key employees of the manager and Cohen & Company during the six-month period ended June 30, 2008 and 2007, respectively.

During the three-month period ended June 30, 2008 and 2007, the consolidated CDO entities that are included in the Company’s consolidated financial statements incurred collateral management fees that are payable to Cohen & Company of $3.8 million and $3.7 million, respectively. During the same periods, Cohen & Company earned origination, structuring and placement fees of $0.6 million and $4.1 million, respectively, relating to services provided to warehouse facilities and CDOs that the Company is invested in. In addition, during the same periods, Cohen & Company received $28 thousand and $4.5 million, respectively, from warehouse facilities and consolidated CDO entities as reimbursement for origination expenses paid to third parties.

During the six-month period ended June 30, 2008 and 2007, the consolidated CDO entities that are included in the Company’s consolidated financial statements incurred collateral management fees that are payable to Cohen & Company of $8.1 million and $6.7 million, respectively. During the same periods, Cohen & Company earned origination, structuring and placement fees of $1.4 million and $16.7 million, respectively, relating to services provided to warehouse facilities and CDOs that the Company is invested in. In addition, during the same periods, Cohen & Company received $43 thousand and $10.2 million, respectively, from warehouse facilities and consolidated CDO entities as reimbursement for origination expenses paid to third parties.

Base management fees and incentive fees incurred, stock-based compensation expense relating to shares of restricted common stock granted to the manager, and collateral management fees paid to Cohen & Company are included in related party management compensation on the consolidated statements of income. Expenses incurred by the manager and reimbursed by the Company are reflected in the respective consolidated statement of income non-investment expense category based on the nature of the expense.

NOTE 10: COMMITMENTS AND CONTINGENCIES AND OTHER MATTERS

Commitments

The leveraged loan CLO vehicles consolidated by the Company are committed to purchase interests in debt obligations of corporations, partnerships and other entities in the form of participations in leveraged loans, which obligate the CLO vehicle to acquire a predetermined interest in such leveraged loans at a specified price on a to-be determined settlement date. As of June 30, 2008, the consolidated CLO vehicles had committed to participate in funding approximately $4.5 million of leveraged loans. The CLO vehicles will use amounts currently included in restricted cash to fund these purchases.

As of June 30, 2008, the consolidated CDO and CLO entities have requirements to purchase $69.7 million of additional collateral assets in order to complete the accumulation of the required amount of collateral assets. Of this amount, $42.0 million has already been advanced to consolidated CDOs and CLOs through CDO and CLO notes payable and is included within restricted cash on the consolidated balance sheet as of June 30, 2008.

Contingencies

The Company is party to various legal proceedings which arise in the ordinary course of business. The Company is not currently involved in any litigation nor, to our knowledge, is any litigation threatened against us, the outcome of which would, in our judgment based on information currently available to us, have a material adverse effect on our financial position or results of operations.

ITEM 2.

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

Certain statements contained in this Quarterly Report on Form 10-Q, including without limitation statements regarding the objectives of management for future operations and statements containing the words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions, constitute “forward-looking statements” within the meaning of the federal securities laws. Such forward-looking statements are subject to known and unknown risks, uncertainties and assumptions which may cause actual results, performance or achievements to differ materially from those anticipated or implied by the forward-looking statements. These risks include our failure to successfully execute our business plan, continued disruption in the U.S. credit markets generally and the mortgage loan and CDO markets particularly, our inability to gain access to additional financing, the limited availability of additional investment portfolios for future acquisition, performance of our existing investments, our failure to maintain REIT status, the cost of capital, as well as the additional risks and uncertainties detailed in our periodic reports and registration statements filed with the Securities and Exchange Commission (“SEC”). We disclaim any obligation to update any such statements or publicly announce any updates or revisions to any of the forward-looking statements contained herein to reflect any change in our expectation with regard thereto or any change in events, conditions, circumstances or assumptions underlying such statements.

Management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including fair value of financial instruments and provision for loan losses. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

Overview

We are a specialty finance company that invests in multiple asset classes with the objective of generating risk-adjusted returns and predictable cash distributions for our stockholders, subject to maintaining our status as a REIT under the Internal Revenue Code and our exemption from regulation under the Investment Company Act. We seek to achieve our investment objectives by investing primarily in the following target asset classes:

•

subordinated debt financings originated by our manager or third parties, primarily in the form of TruPS issued by banks or bank holding companies and insurance companies, and surplus notes issued by insurance companies;

•

mortgage loans, other real estate-related senior and subordinated debt securities, RMBS and CMBS.

We may also invest opportunistically from time to time in other types of investments within our manger’s areas of expertise and experience, subject to maintaining our qualification as a REIT and our exemption from regulation under the Investment Company Act. Our investment guidelines do not impose any limitations on the type of assets in which we may invest.

We are externally managed and advised by Cohen & Company Management, LLC, whom we refer to as our manager, pursuant to a management agreement. Our manager is a wholly-owned subsidiary of Cohen Brothers, LLC, d/b/a Cohen & Company, an alternative investment management firm, which, since 2001, has provided financing to small and mid-sized companies in financial services, real estate and other sectors.

In general, our investment strategy is to acquire investments in our target asset classes on a short-term basis with on and off-balance sheet warehouse facilities or other short-term financing arrangements and finance these investments on a long-term basis with securitization vehicles, including CDOs and CLOs. Our securitization strategies generally provide for match-funding of our assets and liabilities, which typically results in predictable net investment income over the financing term. We use a substantial amount of leverage to seek to enhance our returns. Our ability to manage the cost of borrowings to finance our investments and our ability to obtain adequate financing will have a significant impact on our net investment income and business strategy.

Impact of Market Events on Our Business

The credit markets in the United States began suffering significant disruption in the summer of 2007. This disruption began in the subprime residential mortgage sector and extended to the broader credit and financial markets generally. Available liquidity, particularly through asset-backed securities (ABS) CDOs and other securitizations, declined precipitously during the second half of 2007 and remains depressed as of the date of this filing. Concerns about the capital adequacy of U.S. government-sponsored entities that support the residential mortgage market, such as Fannie Mae and Freddie Mac, increasing commodities prices and continued pricing declines in the U.S. housing market have led to further disruptions in the financial markets, adversely affected regional banks and have exacerbated the longevity and severity of the credit crisis. The disruption in these markets directly impacts our business because our investment portfolio includes investments in MBS, leveraged loans and bank and insurance company debt. We typically finance our investments with on and off-balance sheet warehouse facilities and on-balance sheet CDOs and CLOs. In an effort to seek to offset losses in our investments, we began purchasing credit defaults swaps, or CDS, in 2007.

Our MBS Investments

We invest in MBS through our Kleros Real Estate CDO subsidiaries and other non-consolidated CDO investments. In 2007 and continuing in 2008, the principal U.S. rating agencies downgraded large amounts of MBS, ABS and debt securities of CDOs collateralized by MBS, including investments that are in our portfolio. Since we finance our investments in MBS through the issuance of equity and debt securities of CDOs, our exposure to losses on our consolidated MBS portfolios is limited to our investments in such CDOs.

Our maximum loss from investments in MBS is limited to the $90 million that we invested into the three remaining Kleros Real Estate CDOs. The CDOs are governed by legal indentures that provide us with no rights to the CDOs assets and provide the CDO noteholders with no recourse to us. We consolidate the Kleros Real Estate CDOs in accordance with Financial Accounting Standard Board (“FASB”) Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), which requires that we record the financial position and results of operations of the CDOs in our consolidated financial statements, without consideration that our maximum economic exposure to loss is $90 million. We have effectively written down our remaining $90 million equity investment in the Kleros Real Estate CDOs to zero.

During the second quarter of 2007, the Company began to purchase CDS contracts referenced to certain MBS and CDOs that trade in the public markets. In June 2008, the Company sold the subsidiary that owned the remaining $87.5 million notional of CDS positions for $70.4 million in proceeds (inclusive of the $69.3 million of counterparty margin held as of March 31, 2008). During the

three-month period ended June 30, 2008, the Company recorded a net loss upon disposition of the consolidated subsidiary of $5.6 million, which was offset by approximately $6.2 million of unrealized gains on CDS recorded during the same period. The Company records both realized and unrealized changes in fair value on the CDS contracts within net change in fair value of derivative contracts in the consolidated statements of income (loss). Following the June 2008 sale, the Company no longer holds any investments in CDS.

Our Bank and Insurance TruPS Investments

We invest in TruPS issued by banks and surplus notes issued by insurance companies through our Alesco CDO subsidiaries. As of the date of this filing, we have experienced eleven bank deferrals and no insurance deferrals in our TruPS portfolio. As of June 30, 2008, the aggregate principal amount of investments in the eleven TruPS investments that are defaulted or are currently deferring interest payments is $282.3 million, representing approximately 5.5% of the Company’s combined TruPS portfolio. As of June 30, 2008, the $145 million of defaulted securities, which includes securities issued by IndyMac Bancorp, have been completely written off in the Company’s consolidated financial statements. For the three-months ended June 30, 2008, investment interest income is net of a $4.4 million reserve for interest income related to $245.5 million of the currently deferring or defaulted securities.

Our Leveraged Loan Investments

We invest in leveraged loans through our Emporia CLO subsidiaries and through investments held in on-balance sheet warehouse facilities. As of the date of filing this report, the leveraged loans in our portfolio have not suffered material defaults or losses. However, the general disruption in the structured products markets has made it difficult to securitize leveraged loans through CLOs. As a result, we are holding assets on warehouse lines longer than originally anticipated. We earn returns from the loans while they are on warehouse lines, but we must also maintain cash collateral with the warehouse lenders during the term of the warehouse lines. The cash we maintain as collateral with our warehouse lenders is not available to us to make new investments or pay

distributions until the assets are sold from the warehouse line. We have seen warehouse lenders generally increase their cash collateral requirements as the difficult credit environment has continued. In addition, banks are generally less willing or able to provide warehouse financing in the current environment because their capital is constrained.

Liquidity

As mentioned above, the disruption in the credit markets has severely restricted our ability to complete new CDOs and CLOs. In addition, banks are capital constrained and this severely limits their ability to provide new financing commitments. We expect this situation to continue for the foreseeable future until markets stabilize, credit concerns dissipate and capital becomes less constrained. We are fortunate that the substantial portion of our portfolio is financed with in-place, long-term financing. However, as of June 30, 2008, we had $40.1 million of cash deposited with a warehouse lender to collateralize a warehouse facility for leverage loans. If the securitization markets remain effectively closed for an extended period, we may lose the first loss cash that we had deposited with the warehouse lender. In addition, our inability to maintain compliance with the over-collateralization requirements of our CDO and CLO financing arrangements can materially adversely affect our cash flow from operations and our ability to make distributions to our stockholders for the reasons discussed above. As previously disclosed, the realized tax losses that we have experienced during 2008, including those resulting from the failure of IndyMac Bancorp and losses on MBS in our Kleros Real Estate portfolio, are expected to significantly offset or eliminate our expected taxable income for the year ending December 31, 2008. Decisions regarding future dividends will continue to consider projections regarding our taxable income and are subject to the review and approval of our board of directors.

Critical Accounting Policies

Basis of Presentation

Principles of Consolidation

Under the TruPS-related off-balance sheet warehouse agreements, the Company usually deposits cash collateral with an investment bank and bears the first dollar risk of loss, up to the Company’s collateral deposit, if an investment held under the warehouse facility is liquidated at a loss. This arrangement causes the Company to hold an implicit interest in the Trust VIEs that issued TruPS held by warehouse providers. The primary assets of the Trust VIEs are subordinated debentures issued by third party sponsors of the Trust VIEs in exchange for the TruPS proceeds and the common equity securities of the Trust VIE. These subordinated debentures have terms that mirror the TruPS issued by the Trust VIEs. Upon consolidation of the Trust VIEs, these subordinated debentures, which are assets of the Trust VIE, are included in the Company’s consolidated financial statements and the related TruPS are eliminated. Pursuant to Emerging Issues Task Force Issue No. 85-1: “Classifying Notes Received for Capital Stock,” subordinated debentures issued to Trust VIEs as payment for common equity securities issued by Trust VIEs to third party sponsors are recorded net of the common equity securities issued.

Fair Value of Financial Instruments

•

Financial instruments utilizing Level 1 inputs generally include exchange-traded equity securities listed in active markets and most U.S. Government securities.

•

Financial instruments utilizing Level 3 inputs generally include investments in TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable.


Financial Instrument Description	Carrying Value at January 1, 2008 (Before Adoption of SFAS No. 159)		Transition Adjustment to Accumulated Deficit Increase/(Decrease)			Carrying Value at January 1, 2008 (After Adoption of SFAS No. 159)
Assets:
TruPS and subordinated debentures	$	3,793,930	$	(924,053	)(1)	$	3,793,930
TruPS security-related receivables		740,342		(113,123	)		627,219
MBS		2,091,007		(554,171	)(1)		2,091,007
Liabilities:
TruPS CDO notes payable		4,924,033		838,109	(2)		4,085,924
MBS CDO notes payable		3,852,837		1,804,175	(3)		2,048,662
TruPS obligations		382,600		79,005			303,595

Cumulative effect of the adoption				1,129,942
Minority interest allocation of cumulative adjustment				(22,737	)

Cumulative effect of the adoption to accumulated deficit(4)				1,107,205
Adjustments related to other comprehensive income				1,478,224

Cumulative effect of the adoption to stockholders’ equity			$	2,585,429

(1)

(2)	Includes write-off of deferred issuance costs of $76.9 million.

(3)	Includes write-off of deferred issuance costs of $21.0 million.

(4)	Amount includes $1.9 million of a deferred tax asset recorded upon adoption of SFAS No. 159.

Investments

Transfers of Financial Assets

Revenue Recognition

Derivative Instruments

Accounting for Off-Balance Sheet Arrangements

Income Taxes

Recent Accounting Pronouncements

Our Investment Portfolio

The following table summarizes our allocation of capital and book value as of June 30, 2008 (amounts in thousands, except share and per share data):


	Capital Allocation as of June 30, 2008 (A)			% of Capital		Book Value as of June 30, 2008
TruPS investments	$	239,249		35	%	$	106,040
Leveraged loan investments		88,171		13	%		79,069
Kleros Real Estate MBS investments		90,000		13	%		—
Residential mortgages		86,401		13	%		68,037
Other investments		54,026		8	%		17,616
Total uninvested cash (B)		120,733		18	%		120,733

Total investible capital		678,580		100	%		391,495
Recourse indebtedness		(188,125	)				(188,125	)

Total	$	490,455				$	203,370

Common stock outstanding as of June 30, 2008							59,592,131

Book Value per share						$	3.41

(A)	Represents net cash invested through June 30, 2008.

(B)	Reduced for dividend payable of $15.2 million at June 30, 2008.

TruPS Investments. During the three-month and six-month period ended June 30, 2008 the Company has recorded losses of $1.0 billion and $1.2 billion, respectively, relating to changes in fair value of its TruPS debt securities. The Company determined that these changes in fair value resulted from specific issuer credit matters, widening of credit spreads, volatility in interest rates, and other qualitative factors relating to macro-credit conditions.

The portfolio consists of approximately 76% bank related investments and 24% insurance related investments. The terms of each of our long-term CDO financings include limitations on specific issuer concentrations, which typically limit the par value of the underlying collateral securities included in the CDO from any single issuer to no greater than 3%. As of June 30, 2008, we had three issuers with concentrations ranging from 2.2% to 2.4% of our total TruPS investment portfolio, which includes the defaulted investment securities of IndyMac Bancorp, and no other issuers were greater than 1.6% of our total TruPS investment portfolio. Additionally, the banks included in our TruPS investment portfolio are concentrated in the following states as of June 30, 2008:


California	12.3	%
Texas	11.7	%
Illinois	9.2	%
Georgia	5.2	%
Virginia	4.4	%
Others	57.2	%

Total	100.0	%

Leveraged Loans. We invest in debt obligations of small and mid-sized corporations, partnerships and other entities in the form of participations in first lien and other senior loans and mezzanine loans, which we collectively refer to as leveraged loans because of the high proportion of debt typically in the capital structure of the borrowing entities. As of June 30, 2008, we had investments in approximately $853.0 million of leveraged loans and an allowance for loan losses related to these investments of $14.6 million.

Although the credit markets in the U.S. have experienced significant disruption and deterioration, as of the date of this filing, our leveraged loan portfolio has not suffered material defaults or losses. There can be no assurances that our portfolio will not be subject to material losses, defaults or rating agency downgrades, in the event of the continued deterioration of the U.S. credit markets or overall economy.

Mortgage Loans. As of June 30, 2008, we owned approximately $951.8 million aggregate principal amount of residential prime mortgage loans with a weighted-average Fair Isaac Corp. (“FICO”) score of 734 at origination. As of June 30, 2008, we have recorded an allowance for loan losses of $18.9 million relating to these residential mortgage loans.

The following table summarizes the delinquency statistics of the Company’s residential mortgage loans as of June 30, 2008 (dollar amounts in thousands):


Delinquency Status	Number of Loans	Principal Amount
30 to 59 days	69	$	27,652
60 to 89 days	27		10,111
90 days or more	149		58,212

Total	245	$	95,975

During the three and six-month period ended June 30, 2008, the Company foreclosed on 15 and 30 residential mortgage loans with fair values of $1.7 million and $6.8 million, respectively, which is classified as real estate owned (REO). The Company records REO property at fair value within other assets in its consolidated balance sheet. During the three and six-month period ended June 30, 2008, the Company recorded charge-offs of $3.7 million and $5.9 million, respectively, as a result of foreclosing on these properties. As of June 30, 2008, the Company had $11.7 million of REO property recorded within other assets in the consolidated financial statements.

MBS and Other Investments. As of June 30, 2008, we had investments in $925.2 million of MBS and $1.7 million in other investments. The $925.2 million of MBS collateralize the debt of the three remaining Kleros Real Estate CDOs that we have invested in. Our maximum loss from investments in Kleros Real Estate MBS is limited to our remaining $90 million of invested capital. The CDOs are governed by legal indentures that provide us with no rights to the CDOs assets and provide the CDO noteholders with no recourse to us. We consolidate the three remaining Kleros Real Estate CDOs in accordance with FIN 46R, which requires that we record the financial position and results of operations of the CDOs in our consolidated financial statements, without consideration that our maximum economic exposure to loss is our remaining $90 million investment. We record the investments and CDO debt at fair value.

The following table summarizes ratings of the MBS investments included in our Kleros Real Estate CDOs (categorized based on fair value as of June 30, 2008 as rated by S&P as of July 2008):


S&P Rating Category	Total MBS per Rating Category		% of Total MBS per Rating Category		Amount of Subprime per Rating Category (1)		% of Subprime per Rating Category		Amount of Second- Lien per Rating Category		% of Second- Lien per Rating Category
	(dollars in thousands)
AAA	$	477,062	51.5	%	$	6,829	4.4	%	$	—	0.0	%
AA+		119,407	12.9	%		46,310	29.4	%		264	6.3	%
AA		122,689	13.3	%		15,153	9.7	%		89	2.1	%
AA–		32,405	3.5	%		7,351	4.7	%		29	0.7	%
A+		38,245	4.1	%		12,538	8.0	%		430	10.2	%
A		34,034	3.7	%		14,390	9.2	%		—	0.0	%
A–		1,615	0.2	%		575	0.4	%		85	2.0	%
BBB+		1,334	0.1	%		963	0.6	%		22	0.5	%
BBB		14,511	1.6	%		5,270	3.4	%		807	19.1	%
BBB–		814	0.1	%		—	0.0	%		813	19.3	%
BB+ and below		83,107	9.0	%		47,519	30.2	%		1,684	39.8	%

Total	$	925,223	100.0	%	$	156,898	100.0	%	$	4,223	100.0	%

(1)	We generally consider a loan to a borrower with a FICO score of less than 625 to be a sub-prime loan.

Credit Default Swaps (CDS). During June 2008, the Company sold a subsidiary that owned the remaining $87.5 million notional of CDS positions for $70.4 million in proceeds (inclusive of the $69.3 million of counterparty margin held as of March 31, 2008). During the three-month period ended June 30, 2008, the Company recorded a net loss upon disposition of the consolidated subsidiary of $5.6 million, which was offset by approximately $6.2 million of unrealized gains on CDS recorded during the same period. The Company records both realized and unrealized changes in fair value on the CDS contracts within net change in fair value of derivative contracts in the consolidated statements of income (loss). Following the June 2008 sale, the Company no longer holds any investments in CDS.

Total Indebtedness. As of June 30, 2008 the Company’s consolidated financial statements included total indebtedness of $5.8 billion. Total indebtedness includes recourse indebtedness of $189.6 million and $5.6 billion of non-recourse debt relating to consolidated VIEs. The creditors of each consolidated VIE have no recourse to the general credit of the Company. The Company’s maximum exposure to loss as a result of its involvement with each consolidated VIE is the $461.8 million of capital that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other types of securitization structures. None of the indebtedness shown in the table above subjects the Company to potential margin calls for additional pledges of cash or other assets.

Effective January 1, 2008, we elected the fair value option pursuant to SFAS No. 159 for our TruPS and MBS CDO notes payable and our trust preferred obligations. Upon adoption of SFAS No. 159 we recorded a one-time $2.8 billion increase to accumulated deficit. During the three-months and six-months ended June 30, 2008, we recorded $1.1 billion and $2.1 billion, respectively, of gains relating to changes in fair value of the liabilities.

Stockholders’ Equity. As of June 30, 2008 the Company’s consolidated financial statements included total stockholders’ equity of $203.4 million. On January 1, 2008, we adopted SFAS No. 159 and elected to apply the fair value option for our investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and TruPS obligations. The total impact to stockholders equity that was recorded as of January 1, 2008 due to the adoption of SFAS No. 159 was a gain of $2.6 billion.

Upon the adoption of SFAS No. 159 the match-funded nature of our MBS and TruPS assets and liabilities resulted in changes in fair value of our assets being significantly offset by changes in the fair value of our CDO notes payable liabilities. We will continue to reflect the fair value of these financial assets and liabilities at fair value in our balance sheet, with all corresponding changes in fair value recorded in earnings.

Results of Operations

Comparison of the Three-Month Period Ended June 30, 2008 to the Three-Month Period Ended June 30, 2007

Net income (Loss). Our net loss increased $34 million to approximately ($81.2) million for the three-month period ended June 30, 2008 from a net loss of ($47.2) million for the three-month period ended June 30, 2007. Our net loss for the three-month period ended June 30, 2008 was attributable to changes in fair value of financial instruments recorded in earnings subsequent to our adoption of SFAS No. 159, reclassification into the income statement of MBS related cash flow hedging losses that were previously included in accumulated other comprehensive loss, and net investment income generated by our investments in TruPS, MBS and leveraged loans and investments in residential mortgages. Our net loss for the three-month period ended June 30, 2007 was primarily attributable to net investment income generated by our investments in TruPS, leveraged loans, residential mortgages and MBS, which were offset by impairments on investments of approximately $74.4 million.

Net investment income. Our net investment income increased $9.1 million to $28.0 million for the three-month period ended June 30, 2008 from approximately $18.9 million for the three-month period ended June 30, 2007. The table below summarizes net investment income by investment type for the following periods:

For the Three-Month Period Ended June 30, 2008


Investment Type	Investment Interest Income		Investment Interest Expense			Provision for Loan Losses			Net Investment Income
	(in thousands)
Investments in TruPS	$	73,457	$	(49,379	)	$	—		$	24,078
Investments in Leveraged Loans		14,908		(7,866	)		(2,331	)		4,711
Investments in Mortgage-Backed Securities		34,149		(26,436	)		—			7,713
Investments in Residential Mortgages		14,439		(13,993	)		(5,560	)		(5,114	)
Other investments		567		—			—			567
Recourse indebtedness		—		(3,914	)		—			(3,914	)

Total	$	137,520	$	(101,588	)	$	(7,891	)	$	28,041

For the Three-Month Period Ended June 30, 2007


Investment Type	Investment Interest Income		Investment Interest Expense			Provision for Loan Losses			Net Investment Income
	(in thousands)
Investments in TruPS	$	83,254	$	(70,305	)	$	—		$	12,949
Investments in Leveraged Loans		13,895		(9,045	)		(1,905	)		2,945
Investments in Mortgage-Backed Securities		58,382		(54,139	)		—			4,243
Investments in Residential Mortgages		16,992		(15,807	)		(1,380	)		(195	)
Other investments		810		(35	)		—			775
Recourse indebtedness		—		(1,802)			—			(1,802)

Total	$	173,333	$	(151,133	)	$	(3,285	)	$	18,915

Our investment interest income decreased $35.8 million to $137.5 million for the three-month period ended June 30, 2008 from $173.3 million for the three-month period ended June 30, 2007. The decrease in investment interest income is attributable to a decrease in the weighted-average coupon rates in our target asset classes from 6.5% for the three-month period ended June 30, 2007 to 5.0% for the three-month period ended June 30, 2008, offset by an increase in the Company’s average investment balances from $10.5 billion for the three months ended June 30, 2007 to $11.3 billion for the three months ended June 30, 2008, and the reserving of $4.4 million of TruPS interest income on deferring and defaulting TruPS during the three-month period ended June 30, 2008.

Our investment interest expense decreased $49.5 million to $101.6 million for the three-month period ended June 30, 2008 from $151.1 million for the three-month period ended June 30, 2007. Upon the adoption of SFAS No. 159 we discontinued hedge accounting for a significant portion of our derivatives and therefore, approximately $11.6 million of periodic net interest payments on these interest rate swaps is no longer recorded within net investment income. Additionally, the decrease in investment interest expense is attributable to a decrease in the weighted-average coupon rate for CDO notes payable from 5.8% as of June 30, 2007 to 3.2% as of June 30, 2008.

Our provision for loan losses relates to investments in residential mortgages and leveraged loans. The provision for loan losses increased by $4.6 million, to $7.9 million for the three-month period ended June 30, 2008 from $3.3 million for the three-month period ended June 30, 2007. The increase is primarily a result of the continued increases in the number of delinquent residential mortgage loans experienced in 2008. The 60-plus day delinquencies in our residential mortgage portfolio increased from 2.2% as of June 30, 2007 to 7.2% as of June 30, 2008. We maintain an allowance for residential and commercial mortgages and leveraged loan losses based on management’s evaluation of estimated losses and inherent risks in the portfolios. Specific allowances for losses are established for impaired loans based on a comparison of the recorded carrying value of the loan to either the present value of the loan’s expected cash flow, the loan’s estimated market price or the estimated fair value of the underlying collateral.

Expenses. Our non-investment expenses increased by $0.4 million to $7.7 million for the three-month period ended June 30, 2008 from $7.3 million for the three-month period ended June 30, 2007. During the same periods, these non-investment expenses consisted of related party management compensation of $4.2 million and $4.3 million, respectively, and general and administrative expenses of $3.5 million and $3.0 million, respectively. During both the three-month period ended June 30, 2008 and the three-month period ended June 30, 2007, the Company incurred base and incentive management fees, net of asset management fee credits, of $0. The Company recognized stock-based compensation expense related to shares of restricted common stock granted to the officers of the Company and key employees of the manager and Cohen & Company of $0.4 million and $0.7 million during the three-month period ended June 30, 2008 and the three-month period ended June 30, 2007, respectively.

During the three-month period ended June 30, 2008 and the three-month period ended June 30, 2007, the consolidated CDO entities that are included in the Company’s consolidated financial statements incurred collateral management fees that are payable to Cohen & Company of $3.8 million and $3.7 million, respectively. The collateral management fees are expenses of consolidated CDO entities and relate to the on-going collateral management services that Cohen & Company provides for CDOs. The increase in related party management compensation is primarily attributable to the increase in investments financed through CDO transactions and the collateral manager fees incurred by these consolidated CDO entities.

Our general and administrative expenses are primarily attributable to professional service expenses, including legal services, CDO trustee compensation, rating agency fees, audit and audit-related fees, tax compliance services, and consulting fees relating to Sarbanes-Oxley compliance.

Interest and other income. Our interest and other income decreased by $4.5 million to $1.1 million for the three-month period ended June 30, 2008 from $5.6 million for the three-month period ended June 30, 2007. This decrease is primarily attributable to $4.3 million in reduced interest earned on cash deposits with financial institutions and interest earned on restricted cash of our consolidated CDO entities. The average total cash balance decreased from $433.8 million for the three-month period ended June 30, 2007 to $205.1 million for the three-month period ended June 30, 2008, while the average interest rate earned on cash decreased from 5.2% to 2.2% over the same period.

Net change in fair value of investments in debt securities and non-recourse indebtedness. On January 1, 2008, we adopted SFAS No. 159 and elected to apply the fair value option for our investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and TruPS obligations. During the three-month period ended June 30, 2008, the net change in fair value of investments in debt securities and non-recourse indebtedness was ($132.7) million. The net change in fair value is comprised of $1.22 billion of decreases recorded on our investments in debt securities, which was partially offset by $1.09 billion of gains recorded on liabilities.

Net change in fair value of derivative contracts. During the three-month period ended June 30, 2008 and the three-month period ended June 30, 2007, we recorded change in fair value of derivative contracts of $37.1 million and $17.2 million, respectively. Upon the adoption of FAS No. 159, we discontinued hedge accounting on a significant portion of our interest rate swaps and therefore

all changes in fair value of these interest rate swaps are recorded in earnings. The change in fair value during the three-month period ended June 30, 2008 is attributable to a $30.9 million gain on interest rate swap contracts and a $6.2 million gain on our CDS positions. The interest rate swap gains described above were impacted by the reclassification to the income statement of $40.6 million of MBS related cash flow hedge losses that were previously recorded in accumulated other comprehensive loss. The reclassifications resulted from our determination that the forecasted transactions that the instruments hedge are no longer probable of occurring due to the likelihood of or actual liquidation of our Kleros Real Estate I, II and III portfolios.

Impairments on investments and intangible assets. Our impairments on investments and intangible assets decreased by $70.1 million to $4.3 million for the three-month period ended June 30, 2008 from $74.4 million for the three-month period ended June 30, 2007. The impairments on investments and intangible assets for the three-month period ended June 30, 2008 is primarily attributable to $4.1 million of charge-offs on residential mortgages. During the three-month period ended June 30, 2007, the Company recorded other-than-temporary impairments of $68.9 million in its consolidated available-for-sale MBS portfolio and recorded a $5.5 million impairment on other non-consolidated CDO investments that are primarily collateralized by MBS.

Loss on disposition of consolidated entities. During June 2008, the Company sold a subsidiary that owned the remaining $87.5 million notional of CDS positions for $70.4 million in proceeds (inclusive of the $69.3 million of counterparty margin held as of March 31, 2008). During the three-month period ended June 30, 2008, the Company recorded a net loss upon disposition of the consolidated subsidiary of $5.6 million, which was offset by approximately $6.2 million of unrealized gains on CDS recorded during the same period. The Company records both realized and unrealized changes in fair value on the CDS contracts within net change in fair value of derivative contracts in the consolidated statements of income (loss). Following the June 2008 sale, the Company no longer holds any investments in CDS.

Net realized loss on sale of assets. During the three-month period ended June 30, 2008 and the three-month period ended June 30, 2007, the Company recorded losses on the sale of assets of approximately $1.7 million and $0.7 million, respectively. During the three months ended June 30, 2008, the Company sold on-balance sheet TruPS with a par value of $8.2 million for cash proceeds of $6.5 million.

Minority interests. Minority interests represent the portion of net income generated by consolidated entities that are not attributable to our ownership interest in those entities. Minority interests decreased $9.2 million to ($3.1) million for the three-month period ended June 30, 2008 as compared to $6.1 million for the three-month period ended June 30, 2007. This decrease is primarily attributable to the minority interest allocation of the net change in fair value of investments in debt securities and non-recourse indebtedness.

Benefit/(Provision) for income taxes. Our domestic TRSs are subject to U.S. federal and state income and franchise taxes. An income tax benefit was recorded of $3.0 million relating to a $2.6 million federal tax refund and net operating loss carryforwards from on-balance sheet warehousing facilities for the three-month period ended June 30, 2008. An income tax provision of $(0.2) million was recorded for the three-month period ended June 30, 2007.

Comparison of the Six-Month Period Ended June 30, 2008 to the Six-Month Period Ended June 30, 2007

Net income. Our net income increased $39.1 million to approximately $3.7 million for the six-month period ended June 30, 2008 from a net loss of ($35.4) million for the six-month period ended June 30, 2007. Our net income for the six-month period ended June 30, 2008 was attributable to changes in fair value of financial instruments recorded in earnings subsequent to our adoption of SFAS No. 159, reclassification into the income statement of MBS related cash flow hedging losses that were previously included in accumulated other comprehensive loss, and net investment income generated by our investments in TruPS, MBS and leveraged loans and investments in residential mortgages. Our net income for the six-month period ended June 30, 2007 was primarily attributable to net investment income generated by our investments in TruPS, leveraged loans, residential mortgages and MBS, which were offset by impairments on investments of approximately $74.4 million.

Net investment income. Our net investment income increased $18.8 million to $54.6 million for the six-month period ended June 30, 2008 from approximately $35.8 million for the six-month period ended June 30, 2007. The table below summarizes net investment income by investment type for the following periods:

For the Six-Month Period Ended June 30, 2008


Investment Type	Investment Interest Income		Investment Interest Expense			Provision for Loan Losses			Net Investment Income
	(in thousands)
Investments in TruPS	$	167,554	$	(122,075	)	$	—		$	45,479
Investments in Leveraged Loans		31,915		(18,042	)		(4,970	)		8,903
Investments in Mortgage-Backed Securities		80,898		(64,785	)		—			16,113
Investments in Residential Mortgages		29,988		(28,561	)		(10,485	)		(9,058	)
Other investments		1,060		—			—			1,060
Recourse indebtedness		—		(7,909	)		—			(7,909	)

Total	$	311,415	$	(241,372	)	$	(15,455	)	$	54,588

For the Six-Month Period Ended June 30, 2007


Investment Type	Investment Interest Income		Investment Interest Expense			Provision for Loan Losses			Net Investment Income
	(in thousands)
Investments in TruPS	$	153,154	$	(130,816	)	$	—		$	22,338
Investments in Leveraged Loans		25,557		(16,720	)		(3,220	)		5,617
Investments in Mortgage-Backed Securities		115,060		(107,621	)		—			7,439
Investments in Residential Mortgages		39,301		(35,953	)		(2,239	)		1,109
Other investments		1,579		(35	)		—			1,544
Recourse indebtedness		—		(2,292	)		—			(2,292	)

Total	$	334,651	$	(293,437	)	$	(5,459	)	$	35,755

Our investment interest income decreased $23.3 million to $311.4 million for the six-month period ended June 30, 2008 from $334.7 million for the six-month period ended June 30, 2007. The decrease in investment interest income is attributable to a decrease in the weighted-average coupon rates in our target asset classes from 6.2% for the six-month period ended June 30, 2007 to 5.4% for the six-month period ended June 30, 2008, offset by an increase in the Company’s average investment balances from $10.6 billion for the six months ended June 30, 2007 to $11.5 billion for the six months ended June 30, 2008, and the reserving of $4.4 million of TruPS interest income on deferring and defaulting TruPS during the six-month period ended June 30, 2008.

Our investment interest expense decreased $52.0 million to $241.4 million for the six-month period ended June 30, 2008 from $293.4 million for the six-month period ended June 30, 2007. Upon the adoption of SFAS No. 159 we discontinued hedge accounting for a significant portion of our derivatives and therefore, approximately $16.3 million of periodic net interest payments on these interest rate swaps is no longer recorded within net investment income. Additionally, the decrease in investment interest expense is attributable to a decrease in the weighted-average coupon rate for CDO notes payable from 5.8% as of June 30, 2007 to 3.2% as of June 30, 2008.

Our provision for loan losses relates to investments in residential mortgages and leveraged loans. The provision for loan losses increased by $10.0 million, to $15.5 million for the six-month period ended June 30, 2008 from $5.5 million for the six-month period ended June 30, 2007. The increase is primarily a result of the continued increases in the number of delinquent residential mortgage loans experienced in 2008. The 60-plus day delinquencies in our residential mortgage portfolio increased from 2.2% as of June 30, 2007 to 7.2% as of June 30, 2008. We maintain an allowance for residential and commercial mortgages and leveraged loan losses based on management’s evaluation of estimated losses and inherent risks in the portfolios. Specific allowances for losses are established for impaired loans based on a comparison of the recorded carrying value of the loan to either the present value of the loan’s expected cash flow, the loan’s estimated market price or the estimated fair value of the underlying collateral.

Expenses. Our non-investment expenses increased by $3.0 million to $16.1 million for the six-month period ended June 30, 2008 from $13.1 million for the six-month period ended June 30, 2007. During the same periods, these non-investment expenses consisted of related party management compensation of $8.9 million and $7.7 million, respectively, and general and administrative expenses of $7.2 million and $5.4 million, respectively. During both the six-month period ended June 30, 2008 and the six-month period ended June 30, 2007, the Company incurred base and incentive management fees, net of asset management fee credits of $0. The Company recognized stock-based compensation expense related to shares of restricted common stock granted to the officers of the Company and key employees of the manager and Cohen & Company of $0.8 million and $1.0 million during the six-month period ended June 30, 2008 and the six-month period ended June 30, 2007, respectively.

During the six-month period ended June 30, 2008 and the six-month period ended June 30, 2007, the consolidated CDO entities that are included in the Company’s consolidated financial statements incurred collateral management fees that are payable to Cohen & Company of $8.1 million and $6.7 million, respectively. The collateral management fees are expenses of consolidated CDO entities and relate to the on-going collateral management services that Cohen & Company provides for CDOs. The increase in related party management compensation is primarily attributable to the increase in investments financed through CDO transactions and the collateral manager fees incurred by these consolidated CDO entities.

Interest and other income. Our interest and other income decreased by $9.1 million to $2.6 million for the six-month period ended June 30, 2008 from $11.7 million for the six-month period ended June 30, 2007. This decrease is primarily attributable to $7.7 million in reduced interest earned on cash deposits with financial institutions and interest earned on restricted cash of our consolidated CDO entities. The average total cash balance decreased from $460.7 million for the six-month period ended June 30, 2007 to $192.2 million for the six-month period ended June 30, 2008, while the average interest rate earned on cash decreased from 5.1% to 2.7% over the same period. Additionally, during the six-month period ended June 30, 2007, the Company received a one-time capital commitment fee of $1.2 million from Cohen for its services as first loss provider during the warehouse period.

Net change in fair value of investments in debt securities and non-recourse indebtedness. On January 1, 2008, we adopted SFAS No. 159 and elected to apply the fair value option for our investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and TruPS obligations. During the six-month period ended June 30, 2008, the net change in fair value of investments in debt securities and non-recourse indebtedness was $70.2 million. The net change in fair value is comprised of approximately $2.0 billion of decreases recorded on our investments in debt securities, which was more than offset by approximately $2.1 billion of gains recorded on liabilities.

Net change in fair value of derivative contracts. During the six-month period ended June 30, 2008 and the six-month period ended June 30, 2007, we recorded change in fair value of derivative contracts of $(45.8) million and $19.6 million, respectively. Upon the adoption of FAS No. 159, we discontinued hedge accounting on a significant portion of our interest rate swaps and therefore all changes in fair value of these interest rate swaps are recorded in earnings. The change in fair value during the six month period ended June 30, 2008 is primarily attributable to a $62.9 million loss on interest rate swap contracts and a $17.1 million gain on our CDS positions. The interest rate swap losses described above were impacted by the reclassification to the income statement of $40.6 million of MBS related cash flow hedge losses that were previously recorded in accumulated other comprehensive loss. The reclassifications resulted from our determination that the forecasted transactions that the instruments hedge are no longer probable of occurring due to the likelihood of or actual liquidation of our Kleros Real Estate I, II and III portfolios.

Impairments on investments and intangible assets. Our impairments on investments and intangible assets decreased by $61.6 million to $12.8 million for the six-month period ended June 30, 2008 from $74.4 million for the six-month period ended June 30, 2007. The impairments on investments and intangible assets for the six-month period ended June 30, 2008 is attributable to impairments of our goodwill of $5.0 million, $6.4 million of charge-offs on residential mortgages, and $1.4 million of impairments on other investments. During the six-month period ended June 30, 2007, the Company recorded other-than-temporary impairments of $68.9 million in its consolidated MBS portfolio and recorded a $5.5 million impairment on other non-consolidated CDO investments that are primarily collateralized by MBS.

Net realized loss on sale of assets. During the six-month period ended June 30, 2008, the Company recorded losses on the sale of assets of approximately $3.2 million. These losses are attributable to the sale of leveraged loans and TruPS during the period, for which losses were recorded of $1.4 million and $1.8 million, respectively. During the six-month period ended June 30, 2007, the Company recorded losses on the sale of assets of approximately $4.4 million. These losses were attributable to the sale of adjustable rate residential mortgages and investment securities in CDO entities collateralized by MBS at a loss of $2.0 million and $2.4 million, respectively.

Minority interests. Minority interests represent the portion of net income generated by consolidated entities that are not attributable to our ownership interest in those entities. Minority interests increased $31.1 million to $40.8 million for the six-month period ended June 30, 2008 as compared to $9.7 million for the six-month period ended June 30, 2007. This increase is primarily attributable to the minority interest impact of the net change in fair value of financial instruments.

Benefit/(Provision) for income taxes. Our domestic TRSs are subject to U.S. federal and state income and franchise taxes. An income tax benefit was recorded of $3.4 million relating to a $2.6 million federal tax refund and net operating loss carryforwards from on-balance sheet warehousing facilities for the six-month period ended June 30, 2008. An income tax provision of $(0.6) million was recorded for the six-month period ended June 30, 2007.

Liquidity and Capital Resources

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay dividends and other general business needs. We believe our available cash balances, other financing arrangements and cash flows from operations will be sufficient to fund our currently anticipated liquidity requirements for the next twelve months, but our ability to grow our business will be limited by our ability to obtain future financing and our liquidity could be adversely affected by a decline in our stock price, as discussed below.

Management has evaluated our current and forecasted liquidity and continues to monitor evolving market conditions. Future investment alternatives and operating activities will continue to be evaluated against anticipated current and longer term liquidity demands. Over the next twelve months, we expect that our external management fees payable to our manager under the management agreement will be substantially offset by the collateral management fee credits that we earn. We do not anticipate incurring significant costs payable under the management agreement.

We are currently financing our TruPS, MBS and leveraged loan portfolio with warehouse facilities and CDO notes payable. As of June 30, 2008, the Company is not financing any investments with short-term repurchase agreements that subject the Company to margin calls or potential recourse obligations in excess of posted first loss deposits. Should our currently anticipated liquidity needs exceed our available sources of liquidity, we believe that certain securities in which we have invested could be sold to raise additional cash. Holders of our $140 million aggregate principal amount of outstanding 7.625% Contingent Convertible Senior Notes due 2027 will have the right to require us to repurchase their notes at 100% of their principal amount together with accrued but unpaid interest thereon if, among other things, our common stock ceases to be listed on the NYSE, another established national securities exchange or an automated over-the-counter trading market in the United States. If the average closing price of our common stock on the NYSE is less than $1.00 over 30 consecutive trading days, or if we lose our REIT qualification, the NYSE may elect to commence de-listing procedures for our common stock. If we are unable to remedy the deficiency and remain listed on the NYSE and if we are unable to list our common stock on another established national securities exchange or automated U.S. over-the-counter trading market, there is a risk that some or all holders of our convertible notes will exercise their right to require us to repurchase their notes. There can be no assurance that we would be able to satisfy such repurchase requests. We currently have no commitments for any additional financings, and we may not be able to obtain any additional financing at the times required and on terms and conditions acceptable to us. If we fail to obtain needed additional financing, the pace of our growth would be adversely affected.

As of June 30, 2008, the Company’s consolidated financial statements include $136.0 million of cash and cash equivalents, which includes $15.2 million of cash dividends that were paid to the Company’s shareholders on July 10, 2008.

As of June 30, 2008, the Company’s consolidated financial statements included total indebtedness of $5.8 billion. Total indebtedness includes recourse indebtedness of $189.6 million and $5.6 billion of non-recourse debt relating to consolidated VIEs. The creditors of each consolidated VIE have no recourse to the general credit of the Company. The Company’s maximum exposure to loss as a result of its involvement with each consolidated VIE is the equity that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other types of securitization structures.

Our primary cash needs include the ability to:

•

distribute earnings to maintain our qualification as a REIT;

•

pay costs of borrowings, including interest on such borrowings and expected CDO, CLO and other securitization debt;

•

pay base and incentive fees to our manager and pay other operating expenses;

•

fund investments and discretionary repurchases of our debt and equity securities; and

•

pay federal, state and local taxes of our domestic TRSs.

We intend to meet these short-term requirements through the following:

•

revenue from operations, including interest income from our investment portfolio;

•

interest income from temporary investments and cash equivalents;

•

borrowings under warehouse facilities; and

•

proceeds from future borrowings or offerings of our common stock.

From our inception through the beginning of the credit crisis in August 2007, we sought to finance our assets on a long-term basis through CDOs and CLOs. The disruption in the credit markets has substantially forestalled our ability to execute new CDOs and CLOs. If the securitization markets re-open in the future, the costs of securitizing assets may be higher than what we experienced in the past. Increased securitization costs may cause us to realize lower returns on our equity for investments in future CDOs as compared with the returns that we have realized to date on completed CDOs that have lower financing costs. If securitization costs become unacceptably high, or if securitization financing remains unavailable, we may not be willing or able to complete a securitization for assets that have been purchased using short-term warehouse lines. In that event, we may potentially lose the first loss cash that we had deposited with the warehouse lender. If we are unable to deploy our capital in high-yielding CDO investments quickly or at all, we would need to find alternative investments which may be lower yielding.

CDO Over-collateralization Tests

The terms of the CDO and CLO vehicles that we use to finance our investments generally provide that the principal amount of assets must exceed the principal balance of the related securities to be issued by the CDO or CLO by a certain amount, commonly referred to as “over-collateralization.” The CDO and CLO terms generally provide that, if certain delinquencies and/or losses exceed the specified levels based on the analysis by the rating agencies (or any financial guaranty insurer) of the characteristics of the assets collateralizing the CDO or CLO securities, the required level of over-collateralization may be increased or may be prevented from decreasing as would otherwise be permitted if losses or delinquencies did not exceed those levels. Other tests, based on delinquency levels or other criteria including downgrades by the rating agencies of the underlying portfolio securities of the CDO, may restrict our ability to receive cash distributions from assets collateralizing the CDO or CLO securities. The performance tests may not be satisfied. In addition, collateral management agreements typically provide that if certain over-collateralization ratio tests are failed and an event of default occurs, the collateral management agreement may be terminated by a vote of the security holders and the security holders have the option to liquidate the underlying collateral securities. If the assets held by CDOs and CLOs fail to perform as anticipated, our liquidity may be adversely affected.

The following summarizes certain key over-collateralization test matters for each of our respective target asset classes:

•

MBS and Other Investments— As previously disclosed, the Kleros Real Estate CDOs have all failed over-collateralization tests as a result of significant ratings agency downgrade activity and are no longer making cash distributions to the Company. The net cash flows of the Kleros Real Estate CDOs are currently being used to pay down the controlling class debtholders in each of the Kleros Real Estate CDOs. Despite the fact that each Kleros Real Estate CDO has failed over-collateralization tests, the net interest earnings of the three remaining CDOs will continue to be reflected in the Company’s net investment income and taxable income. In addition, we received written notice from the trustees of Kleros Real Estate I, II, and III that each CDO has experienced an event of default. These events of default resulted from the failure of certain additional over-collateralization tests primarily due to credit rating agency downgrades. The events of default provide the controlling class debtholder in each CDO with the option to liquidate all of the MBS assets collateralizing the particular CDO. The proceeds of any such liquidation would be used to repay the controlling class debtholder.

•

TruPS—Our investments in TruPS are also financed with CDOs that are subject to over-collateralization requirements. The over-collateralization requirements in the TruPS CDOs are typically triggered in the event that more than three percent of the par value of collateral securities that collateralize the CDO debt defer on a principal or interest payment or are otherwise determined to be defaulted in accordance with the indenture for the particular CDO. As of the date of this filing, we have

experienced eleven bank deferrals and no insurance deferrals in our TruPS portfolio. As of June 30, 2008, the aggregate principal amount of investments in the eleven TruPS that are currently deferring or defaulted is $282.3 million, representing approximately 5.5% of the Company’s consolidated trust preferred securities portfolio. The TruPS deferrals and defaults described above have resulted in the over-collateralization tests being triggered in seven of the eight CDOs in which the Company holds equity interests. One of the CDO over-collateralization failures has since been cured, bringing the total number of TruPS CDOs in over-collateralization failure status to six as of June 30, 2008. The trigger of an over-collateralization test in a TruPS CDO means that the Company, as a holder of equity securities, will no longer receive current distributions of cash in respect of its equity interests until sufficient cash or collateral is retained in the CDOs to cure the over-collateralization tests. The Company currently projects that three of the six affected CDOs may cure the over-collateralization failures and recommence making equity distributions within 3 to 6 quarters and the other three may do so within 20 to 35 quarters. These cash flow projections assume zero recovery of principal or interest on any of the currently deferring or defaulted securities and no additional deferrals. There can be no assurance that we will not experience additional deferrals or defaults that will result in further over-collateralization test failures or extend the expected cure periods of the deals currently failing over-collateralization tests.

•

Leveraged Loans—The over-collateralization requirements in the leveraged loan CLOs are typically triggered in the event that we experience significant losses on the sale of assets below par, as well as unrealized fair value adjustments on certain assets as mandated by the indentures which govern our leveraged loan CLOs. The primary cause for such fair value adjustments are default activity, and credit downgrades in the underlying asset pool. In the event that an over-collateralization failure occurs in a leveraged loan CLO, changes to the priority of payments will result in the equity holders, including us, of the CLO not receiving any cash flows until such time as the over-collateralization failure is cured. As of the date of this filing, we have not experienced an over-collateralization failure in any of our leveraged loan CLOs.

Warehouse Financing Arrangements

As of June 30, 2008, we were party to the following agreement which is collateralized by the assets shown below:

Financing Facilities

(and Aggregate Borrowing Capacity)

Termination Date

Assets Being Financed

Leveraged loan related warehouse facility

May 2009

170.4 million

Inflation

We believe that the principal risk to us from inflation is the effect that market interest rates may have on our floating rate debt instruments as a result of future increases caused by inflation. We mitigate against this risk through our financing strategy to match the terms of our investment assets with the terms of our liabilities and, to the extent necessary, through the use of hedging instruments.

Fair Values

For certain of the financial instruments that we own, fair values will not be readily available since there are no active trading markets for these instruments as characterized by currency exchanges between willing parties. Accordingly, fair values can only be derived or estimated for these investments using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated future cash flows is inherently subjective and imprecise. Minor changes in assumptions or estimation methodologies can have a material effect on these derived or estimated fair values. These estimates and assumptions are indicative of the interest rate environments as of June 30, 2008 and do not take into consideration the effects of subsequent interest rate fluctuations.

We note that the values of our investments in MBS, residential mortgages, TruPS, and derivative instruments will be sensitive to changes in market interest rates, interest rate spreads, credit spreads and other market factors. The value of these investments can vary materially from period to period.

Securities Repurchases

In August 2007, our board of directors authorized us to repurchase up to $50 million of our common stock from time to time in open market purchases or privately negotiated transactions. Through June 30, 2008, we had repurchased 420,800 shares under this authorization. We may also repurchase convertible debt securities from time to time in open market purchases or privately negotiated transactions. As of the date of filing of this report we have not repurchased any of our convertible debt securities. There can be no assurance as to the timing or amount of any securities repurchases we may complete.

Off-Balance Sheet Arrangements and Commitments

We may maintain arrangements with various investment banks regarding CDO securitizations and off-balance sheet warehouse facilities. Prior to the completion of a CDO securitization, historically our off-balance sheet warehouse providers have acquired investments in accordance with the terms of the warehouse facility agreements. Pursuant to the terms of the warehouse agreements, we receive all or a portion of the difference between the interest earned on the investments acquired under the warehouse facilities and the interest accrued on the warehouse facilities from the date of the respective acquisitions. Under the warehouse agreements, we are required to deposit cash collateral with the warehouse providers, and as a result, we bear the first dollar risk of loss up to our warehouse deposit if an investment held under the warehouse facility is liquidated at a loss. Upon the completion of a CDO securitization, the cash collateral held by the warehouse provider is returned to us. In the event that we are unable to obtain long-term CDO financing for the accumulated warehouse collateral, our cash collateral is at risk and may not be returned to the Company. The duration of a warehouse facility is generally at least nine months. These arrangements are deemed to be derivative financial instruments and are recorded by us at fair value in each accounting period with the change in fair value recorded in earnings.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Our exposure to market risk pertains to losses resulting from changes in interest rates and equity security prices. We are exposed to credit risk and interest rate risk related to our investments in assets in our target asset classes.

Market Risk

The credit markets in the United States began suffering significant disruption in the summer of 2007. This disruption began in the subprime residential mortgage sector and extended to the broader credit and financial markets generally. Available liquidity, particularly through asset-backed securities (ABS) CDOs and other securitizations, declined precipitously during the second half of 2007 and remains depressed as of the date of this filing. Concerns about the capital adequacy of U.S. government-sponsored entities that support the residential mortgage market, such as Fannie Mae and Freddie Mac, increasing commodities prices and continued pricing declines in the U.S. housing market have led to further disruptions in the financial markets, adversely affected regional banks and have exacerbated the longevity and severity of the credit crisis. The disruption in these markets directly impacts our business because our investment portfolio includes investments in mortgage-backed securities, or MBS, leveraged loans and bank and insurance company debt.

The disruption in the credit markets has severely restricted our ability to complete new CDOs and CLOs. In addition, banks are capital constrained and this severely limits their ability to provide new financing commitments. We expect this situation to continue for the foreseeable future until markets stabilize, credit concerns dissipate and capital becomes less constrained. We are fortunate that the substantial portion of our portfolio is financed with in-place, long-term financing. However, as of June 30, 2008, we had $40.1 million of cash deposited with warehouse lenders to collateralize a warehouse facility for leveraged loans. If the securitization markets remain effectively closed for an extended period, we may lose the first loss cash that we had deposited with the warehouse lender.

Interest Rate Risk

Interest rates may be affected by economic, geopolitical, monetary and fiscal policy, market supply and demand and other factors generally outside our control, and such factors may be highly volatile. Our interest rate risk sensitive assets and liabilities and financial derivatives typically will be held for long-term investment and not held for sale purposes. Our intent in structuring CDO and CLO transactions and other securitizations will be to limit interest rate risk with a financing strategy that matches the terms of our investment assets with the terms of our liabilities and, to the extent necessary, through the use of hedging instruments. Although we have had only limited operations, we do not believe an increase or decrease in interest rates will have a material impact on our net equity in our overall portfolio.

We generally make investments that are either floating rate or fixed rate. Our floating rate investments will generally be priced at a fixed spread over an index such as LIBOR that reprices either quarterly or every 30 days based upon movements in effect at each measurement date. Given the frequency of future price changes in our floating rate investments, changes in interest rates are not expected to have a material effect on the value of these investments. Increases or decreases in LIBOR will have a corresponding increase or decrease in our interest income and the match funded interest expense, thereby mitigating the net earnings impact on our overall portfolio. In the event that long-term interest rates increase, the value of our fixed-rate investments would be diminished. We have hedged this risk where the benefit outweighs the cost of the hedging strategy. Such changes in interest rates would not have a material effect on the income of these investments, which generally will be held to maturity.

Through June 30, 2008, we entered into various interest rate swap agreements to hedge variable cash flows associated with CDO notes payable and repurchase agreements. These interest rate swap contracts have an aggregate notional value of $2.4 billion and are used to swap the variable cash flows associated with variable rate CDO notes payable and repurchase agreements into fixed-rate payments. As of June 30, 2008, the interest rate swaps had an aggregate liability fair value of $103.8 million. Changes in the fair value of interest rate swaps that were not designated as hedges under SFAS No. 133 are recorded in earnings.

There have been no material changes in Quantitative and Qualitative disclosures in 2008 from the disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2007. See discussion of quantitative and qualitative disclosures about market risk under “Item 7A—Quantitative and Qualitative Disclosures About Market Risk” included in our Annual Report on Form 10-K for the year ended December 31, 2007.

ITEM 4.

CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We have established disclosure controls and procedures to ensure that material information relating to the Company, including our consolidated subsidiaries, is made known to the officers who certify our financial reports and to other members of senior management and the board of directors. Under the supervision, and with the participation of our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934 (“Exchange Act”) as of June 30, 2008. Based on that evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures were effective at June 30, 2008, to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

On June 8, 2006, our loan to Beech Thicket Spring, Inc., Communities of Penland, LLC, COP Preservation Partners, LLC, F.W., Inc., The Penland Reserve Tract, LLC, and Triad Apartment Group, LLC in the original principal amount of $16.7 million (the “Penland Loan”) matured. The outstanding balance was $11,745,589.50. The Penland Loan was guaranteed by five individuals, Anthony R. Porter, Dorothy M. Porter, Frank A. Amelung, Eugenia Amelung and Richard L. Amelung (collectively “Guarantors”). On January 12, 2007, we commenced an action in the United Stated District Court to confirm a $13,035,243.12 arbitration award against the Guarantors. The case is styled Alesco Financial Inc. v. Anthony R. Porter, Dorothy M. Porter, Frank Amelung, Eugenia Amelung and Richard Amelung, in the United States District Court in the Middle District of Florida, Case No.: 3:07-cv-00032-HWM-HTS. On March 29, 2007, the court entered judgment (the “Judgment”) for us in the amount of $13,060,614.63. We registered the Judgment in the states of Arkansas (Western District, Case No. 07 MC 00011), Georgia (Savannah Division, Case No. MC 407-002), New Mexico (Case No. MC 07-03), North Carolina (Eastern District, Case No. 1:07 MC 15), South Carolina (Case No. 9:0 MC 42) and Wyoming (Case No. 07 MC 21). Frank A. Amelung, Eugenia Amelung and Richard L. Amelung have sought protection in the United States Bankruptcy Court in the Southern District of Florida, West Palm Beach Division, In Re: Frank A. Amelung, Jr. and Eugenia Marie Amelung, Chapter 7 Debtors, Case No.: 07-15492-BKC-PGH, and In Re: Richard L. Amelung, Debtor Chapter 7, Case No.: 07-15493-BKC-PGH, respectively. Frank A. Amelung, Eugenia Marie Amelung and Richard L. Amelung subsequently sought protection in the United States Bankruptcy Court in the Southern District of Florida, West Palm Beach Division. The cases are In re Frank A. Amelung, Jr., and Eugenia Marie Amelung, Case No. 07-15492-PGH, and In re Richard L. Amelung, Case No. 07-15493-PGH. Alesco has made a claim in both cases for the amount of the Judgment, reduced as the Peerless Loan otherwise is collected. At least two parties, including the Trustee in each case, have filed pleadings objecting to the discharge of Frank A. Amelung and Richard L. Amelung. The ability to collect any of the Judgment in the bankruptcy proceedings is unknown at this time. We are considering all options to pursue collection of the Judgment in the various jurisdictions, subject to limitations imposed by law.

The Attorney General of North Carolina on June 6, 2007, filed suit against one or more of the Borrowers and Guarantors of the Penland Loan described above, among others, in the case styled State of North Carolina ex rel, Roy Cooper, Attorney General vs. Peerless Real Estate Services, Inc., Village of Penland, L.L.C., MFSL Landholdings, L.L.C., Communities of Penland, L.L.C., COP Land Holdings, L.L.C., PG Capital Holdings, L.L.C., Anthony Porter, Frank Amelung, Richard Amelung, J. Kevin Foster, Neil O’Rourke, Michael Yeomans, and A. Greg Anderson, General Court of Justice, Superior Court Division, State of North Carolina, Wake County, Case No.: 07-CVS-9006. The North Carolina Attorney General alleged that the defendants in the case obtained monies from consumers in violation of North Carolina law relating to unfair or deceptive practices affecting commerce. The court in this case has issued an order appointing a receiver for the assets of the corporate defendants in the case, Peerless Real Estate Services, Inc., Village of Penland, L.L.C., MFSL Landholdings, L.L.C., Communities of Penland, L.L.C., COP Land Holdings, L.L.C., PG Capital Holdings, L.L.C. We are not a named party in this action, but the receivership includes a substantial part of the real property collateral held by us to secure the Penland Loan. The complaint filed by the North Carolina Attorney General seeks to void all contracts between the named defendants and consumers in the alleged deceptive scheme identified in the complaint, the return of all monies obtained by the named defendants in the alleged deceptive scheme, civil penalties against the named defendants and attorney fees from the named defendants. The Order Appointing Receiver authorizes the Receiver, among other things, to sell and dispose of property of the Borrowers in the receivership free and clear of all liens and other collateral interests, which liens or other collateral interests will then attach to the proceeds. We have not received notice of any such sale or disposition of our collateral, and we plan to protect vigorously any and all liens and other collateral interests in the collateral for the Penland Loan. We intend to continue to foreclose some or all our collateral, which may require this court’s approval, and pursue collection by all other available means.

Item 1A.

Risk Factors

The risks described under “Item 1A – Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2007, could materially and adversely affect our business, financial condition and results of operations. The risk factors discussed in that Form 10-K and in this Quarterly Report on Form 10-Q do not identify all risks that we face because our business operations could also be affected by additional factors that are not presently known to us or that we currently consider to be immaterial to our operations.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

(a)

The following matters were submitted to a vote of our security holders at the 2008 Annual Meeting of Stockholders of the Company, which was held at 10:00 a.m., Eastern Time, on June 18, 2008 at the Company’s headquarters located at Cira Centre, 2929 Arch Street, 17^th Floor, Philadelphia, Pennsylvania 19104.

The three proposals presented at the meeting were:

To elect nine directors to the Company’s Board of Directors.

To amend the Company’s 2006 Long-Term Incentive Plan to increase the total number of shares of common stock available to be granted under the Plan.

To ratify the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for the year ending December 31, 2008.

The total number of shares of common stock entitled to vote at the 2008 Annual Meeting of Stockholders of the Company was 59,455,965, of which 55,202,721 shares, or 92.85%, were present in person or by proxy.

(b)

Not required.

(c)

The voting results were as follows:

Each of the following nine directors was elected to the Company’s Board of Directors to serve until the next annual meeting of stockholders in 2009 or until his successor is duly elected and qualified, and received the number of votes set forth below. There were no abstentions or broker non-votes.


Nominee	For	Withheld
Rodney E. Bennett	52,793,567	2,409,154
Marc Chayette	52,742,781	2,459,940
Daniel G. Cohen	51,689,257	3,513,464
Thomas P. Costello	52,755,039	2,447,682
G. Steven Dawson	52,709,713	2,493,008
Jack Haraburda	52,774,744	2,427,977
James J. McEntee, III	52,735,745	2,466,976
Lance Ullom	52,724,217	2,478,504
Charles W. Wolcott	52,829,836	2,372,885

There was no solicitation in opposition to the foregoing nominees by stockholders.

The stockholders approved the Company’s amended 2006 Long-Term Incentive Plan. The number of votes cast for and against the proposal and the number of abstentions and broker non-votes were as follows:


For	Against	Abstain	Broker Non-Votes
21,496,284	8,917,282	770,875	28,271,524

The stockholders ratified the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for the year ending December 31, 2008. The number of votes cast for and against the ratification of the independent registered public accounting firm and the number of abstentions and broker non-votes were as follows:


For	Against	Abstain	Broker Non-Votes
53,845,011	761,378	596,333	4,253,243

Item 5.

Other Information

None.

Item 6.

Exhibits

(a) Exhibits – see “Exhibit Index.”

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


	ALESCO FINANCIAL INC.

	By:	/s/ James J. McEntee, III
		James J. McEntee, III
Date: August 6, 2008		Chief Executive Officer

	ALESCO FINANCIAL INC.

	By:	/s/ John J. Longino
		John J. Longino
Date: August 6, 2008		Chief Financial Officer

EXHIBIT INDEX


Exhibit No.		Description
2.1		Amended and Restated Agreement and Plan of Merger, dated as of July 20, 2006, by and among Alesco Financial Inc., Alesco Financial Trust and Jaguar Acquisition Inc. (incorporated by reference to Annex A to our Proxy Statement on Schedule 14A filed with the SEC on September 8, 2006).

2.2		Letter Agreement dated September 5, 2006 by and among Alesco Financial Inc., Alesco Financial Trust and Jaguar Acquisition Inc. and the attached Registration Rights Provisions (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on September 5, 2006).

2.3		Letter Agreement dated September 29, 2006 by and among Alesco Financial Inc., Alesco Financial Trust and Jaguar Acquisition Inc. (incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed with the SEC on September 29, 2006).

3.1		Second Articles of Amendment and Restatement (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to our Registration Statement on Form S-11 (Registration No. 333-111018) filed with the SEC on February 6, 2004).

3.2		Articles of Amendment changing our name to Alesco Financial Inc. (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-3 (Registration No. 333-138136) filed with the SEC on October 20, 2006).

3.3		By-laws, as amended (incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed with the SEC on October 11, 2005).

4.1		Form of Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

4.2		Form of 7.625% Contingent Convertible Senior Notes due 2027 (incorporated by reference to Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC on May 21, 2007).

4.3		Registration Rights Agreement, dated as of May 15, 2007, by and between Alesco Financial Inc. and RBC Capital Markets Corporation (incorporated by reference to Exhibit 4.3 to our Current Report on Form 8-K filed with the SEC on May 21, 2007).

4.4		Indenture, dated as of May 15, 2007, by and between Alesco Financial Inc. and U.S. Bank National Association (incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC on May 21, 2007).

4.5		Junior Subordinated Indenture, dated as of June 25, 2007, by and between Alesco Financial Inc. and Wells Fargo Bank, N.A. (incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC on June 29, 2007).

4.6		Indenture, dated as of June 29, 2007, by and among Bear Stearns ARM Trust 2007-2, Citibank, N.A. and Wells Fargo Bank, N.A. (incorporated by reference to Exhibit 4.6 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.1		Management Agreement, dated as of January 31, 2006, by and between Alesco Financial Trust and Cohen Brothers Management, LLC (incorporated by reference to Annex E to our Proxy Statement on Schedule 14A filed with the SEC on September 8, 2006).

10.2		Shared Facilities and Services Agreement, dated as of January 31, 2006, by and between Cohen Brothers Management, LLC and Cohen Brothers, LLC (incorporated by reference to Exhibit 10.3 to Amendment No. 1 to our Registration Statement on Form S-3 (Registration No. 333-137219) filed with the SEC on October 5, 2006).


Exhibit No.		Description
10.3		Letter Agreement, dated January 31, 2006, by and between Alesco Financial Trust and Cohen Brothers, LLC, relating to certain rights of first refusal and non-competition arrangements between the parties (incorporated by reference to Exhibit 10.4 to Amendment No. 1 to our Registration Statement on Form S-3 (Registration No. 333-137219) filed with the SEC on October 5, 2006).

10.4		Master Repurchase Agreement, dated as of February 28, 2006, by and between Bear Stearns Mortgage Capital Corporation and Alesco Loan Holdings Trust (incorporated by reference to Exhibit 10.10 to our Annual Report on Form 10-K filed with the SEC on March 16, 2007).

10.5		Separation Agreement and General Release, dated July 14, 2006, by and between Sunset Financial Resources, Inc. and George Deehan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on July 26, 2006).

10.6		Assignment and Assumption Agreement, dated as of October 6, 2006, by and between Alesco Financial Inc. and Cohen Brothers Management, LLC, transferring the agreement referred to in Exhibit 10.1 hereto to Alesco Financial Inc. (incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-3 (Registration No. 333-138136) filed with the SEC on October 20, 2006).

10.7		Letter Agreement, dated October 18, 2006, by and between Alesco Financial Inc. and Cohen & Company, LLC, transferring the agreement referred to in Exhibit 10.1 hereto to Alesco Financial Inc. (incorporated by reference to Exhibit 10.5 to our Registration Statement on Form S-3 (Registration No. 333-138136) filed with the SEC on October 20, 2006).

10.8		Credit Agreement, dated as of September 29, 2006, by and among Alesco Financial Holdings, LLC, Alesco Financial Trust and Royal Bank of Canada (incorporated by reference to Exhibit 10.9 to our Annual Report on Form 10-K filed with the SEC on March 16, 2007).

10.9		Credit Agreement, dated as of March 27, 2007, by and among Alesco Financial Holdings, LLC, Alesco Financial Inc., Royal Bank of Canada, U.S. Bank National Association and Royal Bank of Canada (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on April 3, 2007).

10.10		Letter Agreement, dated April 10, 2007, by and among Alesco Financial Inc., Alesco Warehouse Conduit, LLC, Cohen & Company Financial Management, LLC and Cohen & Company, in relation to the Note Purchase Agreement, dated December 5, 2006, by and among PFW III, Ltd., the investors party thereto, Alesco Warehouse Conduit LLC, as initial subordinated noteholder and ABN Amro Bank N.V. (incorporated by reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007).

10.11		Letter Agreement, dated April 23, 2007, by and among Alesco Financial Inc., Alesco Holdings, Ltd., Strategos Capital Management, LLC and Cohen & Company, in relation to the Warehouse Risk Sharing Agreement, dated as of February 7, 2007, between Merrill Lynch and Alesco Holdings, Ltd. (incorporated by reference to Exhibit 10.3 to our Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007).

10.12		Purchase Agreement, dated as of May 9, 2007, by and between Alesco Financial Inc. and RBC Capital Markets Corporation) (incorporated by reference to Exhibit 1.1 to our Current Report on Form 8-K filed with the SEC on May 10, 2007).

10.13		Underwriting Agreement, dated June 20, 2007, by and between Alesco Financial Inc. and RBC Capital Markets Corporation (incorporated by reference to Exhibit 1.1 to our Current Report on Form 8-K filed with the SEC on June 22, 2007).

10.14		Amended and Restated Trust Agreement, dated as of June 25, 2007, by and among Alesco Financial Inc., Wells Fargo Bank, N.A., Wells Fargo Delaware Trust Company and the administrative trustees named therein (incorporated by reference to Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC on June 29, 2007).


Exhibit No.		Description
10.15		Amended and Restated Trust Agreement, dated as of June 29, 2007, by and among Structured Asset Mortgage Investments II Inc., Wilmington Trust Company, Wells Fargo Bank, N.A. and acknowledged by Alesco Financial Inc. (incorporated by reference to Exhibit 10.13 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.16		Mortgage Loan Purchase Agreement, dated as of June 29, 2007, by and between Alesco Financial Inc. and Structured Asset Mortgage Investments II Inc. (incorporated by reference to Exhibit 10.14 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.17		Sale and Servicing Agreement, dated as of June 29, 2007, by and among Structured Asset Mortgage Investments II Inc., Bear Stearns ARM Trust 2007-2, Alesco Financial Inc., Citibank, N.A. and Wells Fargo Bank, N.A., as securities administrator and master servicer (incorporated by reference to Exhibit 10.15 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.18		Guarantee Agreement, dated as of June 29, 2007, by and between Alesco Financial Inc. and Alesco Loan Holdings Trust (incorporated by reference to Exhibit 10.16 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.19		2006 Long-Term Incentive Plan, as amended (incorporated by reference to Annex A to our Proxy Statement on Schedule 14A filed with the SEC on April 30, 2007).

10.20		Form of Restricted Share Award Agreement (incorporated by reference to Exhibit 10.7 to our Annual Report on Form 10-K filed with the SEC on March 16, 2007).

10.21		Form of Indemnification Agreement by and between Alesco Financial Inc. and each of its directors and officers (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on October 20, 2006).

11.1		Statement Regarding Computation of Per Share Earnings.***

31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, as amended.*

31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, as amended.*

32		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended.**

*	Filed herewith.

**	Furnished herewith.

***	Data required by Statement of Financial Accounting Standard No. 128, Earnings per Share, is provided in Note 8 to the consolidated financial statements included in this report.

All other schedules have been omitted because the required information of such other schedules is not present, or is not present in amount sufficient to require submission of the schedule.