UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X]             QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED:  SEPTEMBER 30, 2012

OR

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

EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER:  1-34451

CREXUS INVESTMENT CORP.

(Exact name of Registrant as specified in its Charter)

MARYLAND	26-2652391
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

1211 AVENUE OF THE AMERICAS, SUITE 2902

NEW YORK, NEW YORK

(Address of principal executive offices)

10036

 (Zip Code)

(646) 829-0160

(Registrant’s telephone number, including area code)

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

Yes þ No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ No o

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

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Class	Outstanding at November 7, 2012
Common Stock, $.01 par value	76,630,528

i

CREXUS INVESTMENT CORP.

FORM 10-Q

TABLE OF CONTENTS

Part I.     FINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements:
Consolidated Statements of Financial Condition at September 30, 2012 (Unaudited) and December 31, 2011 (Derived from the audited financial statements at December 31, 2011)	1
Consolidated Statements of Comprehensive Income for the Quarters and Nine Months Ended September 30, 2012 and 2011 (Unaudited)	2
Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2012 and 2011 (Unaudited)	3
Consolidated Statements of Cash Flows for the Quarters and Nine Months Ended September 30, 2012 and 2011 (Unaudited)	4
Notes to Consolidated Financial Statements (Unaudited)	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3. Quantitative and Qualitative Disclosures about Market Risk	46
Item 4. Controls and Procedures	52
Part II.     OTHER INFORMATION
Item 1. Legal Proceedings	53
Item 1A. Risk Factors	53
Item 6. Exhibits	54
SIGNATURES	55

ii

PART I.           FINANCIAL INFORMATION

Item 1.  CONSOLIDATED FINANCIAL STATEMENTS

CREXUS  INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
	September 30, 2012		December 31, 2011
	(unaudited)			(1)
Assets:
Cash and cash equivalents	$	105,575	$	202,814
Commercial real estate loans net of allowance for loan losses ($0 and $369, respectively)
Senior		146,437		374,348
Subordinate		38,837		71,517
Mezzanine		546,541		306,936
Preferred equity held for investment		39,769		-
Real estate held for sale		41,514		-
Investment in real estate, net		33,926		33,196
Intangible assets, net		5,201		-
Rents receivable		221		32
Accrued interest receivable		5,116		2,608
Other assets		5,275		1,420
Total assets	$	968,412	$	992,871
Liabilities:
Mortgages payable	$	19,150	$	16,600
Participation sold (non-recourse)		-		14,755
Accrued interest payable		-		6
Accounts payable and other liabilities		4,864		4,048
Dividends payable		24,523		26,817
Intangible liabilities, net		1,938		-
Investment management fees payable to affiliate		3,450		3,488
Total liabilities		53,925		65,714
Stockholders' Equity:
Common stock, par value $0.01 per share, 1,000,000,000 shares
authorized, 76,630,528 and 76,620,112 shares issued and outstanding, respectively		766		766
Additional paid-in-capital		890,862		890,757
Retained earnings		22,859		35,634
Total stockholders' equity		914,487		927,157
Total liabilities and stockholders' equity	$	968,412	$	992,871
(1) Derived from the audited consolidated statements of financial condition at December 31, 2011.
See notes to consolidated financial statements.

1

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except share and per share data)
	For the Quarter Ended						For the Nine Months Ended
	September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Net interest income:
Interest income	$	26,841		$	44,174		$	67,745		$	64,672
Interest expense		(187	)		(21	)		(857	)		(2,295	)
Servicing fees		(149	)		(213	)		(378	)		(429	)
Net interest income		26,505			43,940			66,510			61,948
Other income:
Realized loss on sale of loan		-			-			(525	)		-
Realized gains on sales of investments		-			-			-			13,925
Miscellaneous fee income		126			217			768			217
Rental income		809			-			2,332			-
Total other income		935			217			2,575			14,142
Other expenses:
Provision for loan losses, net		-			-			2,803			127
Management fees to affiliate		3,446			3,373			10,343			7,398
General and administrative expenses		1,327			848			5,217			1,942
Amortization expense		105			-			334			-
Depreciation expense		271			-			816			-
Total other expenses		5,149			4,221			19,513			9,467
Income before income tax		22,291			39,936			49,572			66,623
Income tax		6			-			39			1
Net income from continuing operations		22,285			39,936			49,533			66,622
Net income from discontinued operations (net of tax expense of $425, $0, $2,284 and $0, respectively)		2,903			-			4,379			-
Gain on sale from discontinued operations		-			-			1,774			-
Impairment charges		(2,560	)		-			(2,560	)		-
Total income from discontinued operations		343			-			3,593			-
Net Income	$	22,628		$	39,936		$	53,126		$	66,622
Net income per average share-basic and diluted, continuing operations		0.29			0.52			0.65		$	1.15
Total income per average share-basic and diluted, discontinued operations		0.01			-			0.04			-
Net income per average share-basic and diluted	$	0.30		$	0.52		$	0.69		$	1.15
Dividend declared per share of common stock	$	0.32		$	0.30		$	0.86		$	0.78
Weighted average number of shares outstanding-basic and diluted		76,630,528			76,620,112			76,625,054			57,887,511
Comprehensive income:
Net income	$	22,628		$	39,936		$	53,126		$	66,622
Other comprehensive income:
Unrealized gains on securities available-for-sale		-			1,649			-			7,847
Reclassification adjustment for realized gains included in net income		-			-			-			(13,925	)
Total other comprehensive income		-			1,649			-			(6,078	)
Comprehensive income	$	22,628		$	41,585		$	53,126		$	60,544
See notes to consolidated financial statements.

2

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
(unaudited)
					Accumulated
	Common		Additional		Other
	Stock Par		Paid-in		Comprehensive			Retained
	Value		Capital		Income			Earnings			Total
Balance, December 31, 2010	$	181	$	257,014	$	10,475		$	365		$	268,035
Net income		-		-		-			66,622			66,622
Other comprehensive loss		-		-		(6,078	)		-			(6,078	)
Net proceeds from common stock
offering, with affiliates		50		57,450		-			-			57,500
Net proceeds from common stock
follow-on offerings		535		576,293		-			-			576,828
Common dividends declared, $0.78 per share				-		-			(46,309	)		(46,309	)
Balance, September 30, 2011	$	766	$	890,757	$	4,397		$	20,678		$	916,598
Balance, December 31, 2011	$	766	$	890,757	$	-		$	35,634		$	927,157
Net income		-		-		-			53,126			53,126
Restricted stock grants		-		105		-			-			105
Common dividends declared, $0.86 per share		-		-		-			(65,901	)		(65,901	)
Balance, September 30, 2012	$	766	$	890,862	$	-		$	22,859		$	914,487
See notes to consolidated financial statements.

3

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
	For the Quarter ended						For the Nine Months ended
	September 30, 2012 (unaudited)			September 30, 2011 (unaudited)			September 30, 2012 (unaudited)			September 30, 2011 (unaudited)
Cash Flows From Operating Activities:
Net income	$	22,628		$	39,936		$	53,126		$	66,622
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Net amortization of investment premiums and discounts		(8,037	)		(30,238	)		(21,730	)		(31,456	)
Amortization of origination fees		(126	)		(84	)		(418	)		(84	)
Realized gain on sale of investments		-			-			(1,774	)		(13,925	)
Loss on sale of loan		-			-			525			-
Provision for loan losses, net		-			-			2,803			127
Impairment charges on real estate held for sale		2,560			-			2,560			-
Restricted stock grants		-			-			105			-
Amortization of intangible assets and liabilities, net		73			-			242			-
Depreciation		271			-			816			-
Changes in operating assets:
Decrease (increase) in accrued interest receivable		(976	)		(361	)		(2,508	)		(1,087	)
Decrease (increase) in principal receivable from servicer		11,429			-			-			-
Decrease (increase) in other assets		(2,748	)		(574	)		(3,856	)		686
Decrease (increase) in rents receivable		(67	)		-			(188	)		-
Changes in operating liabilities:
Increase (decrease) in accounts payable and other liabilities		1,181			1,299			3,520			1,485
Increase (decrease) in investment management fee payable to affiliate		24			29			(38	)		2,724
Increase (decrease) in accrued interest payable		-			(19	)		(6	)		(290	)
Net cash provided by (used in) operating activities		26,212			9,988			33,179			24,802
Cash Flows From Investing Activities:
Mortgage-backed securities portfolio:
Purchases		-			-			-			(209,924	)
Sales		-			-			-			214,771
Principal payments		-			10,721			-			26,031
Loans and preferred equity held for investment portfolio:
Purchases net of discount/loan originations		(124,841	)		(259,884	)		(390,958	)		(805,187	)
Sales		-			-			49,200			-
Principal payments		37,768			314,983			288,282			331,539
Real estate portfolio:
Purchases of real estate		-			-			(5,050	)		-
Sales		-			-			10,508			-
Net cash provided by (used in) investing activities		(87,073	)		65,820			(48,018	)		(442,770	)
Cash Flows From Financing Activities:
Net proceeds (expense) from common stock offerings		-			-			-			576,828
Net proceeds from common stock offering with affiliates		-			-			-			57,500
Proceeds from repurchase agreements		-			-			-			46,550
Payments on repurchase agreements		-			(46,550	)		-			(46,550	)
Proceeds from collateralized mortgage borrowings		-			-			2,550			-
Payments on structured financing		-			-			(14,755	)		-
Payments on secured financing		-			-			-			(172,837	)
Payment of underwriters fee		(2,000	)		-			(2,000	)		-
Dividends paid		(20,692	)		(19,155	)		(68,195	)		(27,309	)
Net cash (used in) provided by financing activities		(22,692	)		(65,705	)		(82,400	)		434,182
Net increase (decrease) in cash and cash equivalents		(83,553	)		10,103			(97,239	)		16,214
Cash and cash equivalents at beginning of period		189,128			37,130			202,814			31,019
Cash and cash equivalents at end of period	$	105,575		$	47,233		$	105,575		$	47,233
Supplemental disclosure of cash flow information:
Interest paid	$	167		$	40		$	481		$	2,585
Taxes paid	$	128			-		$	175		$	1
Non cash investing activities:
Reclassification of loans to real estate upon deed in lieu of foreclosure	$	-		$	-		$	52,800		$	-
Reduction of non-accretable  yield due to principal writedown	$	-		$	16,002					$	16,002
Rate and term financing				$	-		$	45,000		$	-
Net change in unrealized gains(losses) on available-for-sale securities	$	-		$	1,649		$	-		$	(6,078	)
Non cash financing activities:
Common dividends declared, not yet paid	$	24,523		$	22,986		$	24,523		$	22,986
See notes to consolidated financial statements.

4

CREXUS INVESTMENT CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

 (unaudited)

1.   Organization

CreXus Investment Corp. (the “Company”) was organized in Maryland on January 23, 2008.  The Company commenced operations on September 22, 2009 upon completion of its initial public offering.  The Company, directly or through its subsidiaries, acquires, manages and finances an investment portfolio of commercial real estate loans and other commercial real estate debt, commercial real property, commercial mortgage-backed securities (“CMBS”), other commercial real estate-related assets and Agency residential mortgage-backed securities (“Agency RMBS”) and has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended.  As a REIT, the Company will generally not be subject to U.S. federal or state corporate taxes on its income to the extent that qualifying distributions are made to stockholders and the REIT requirements, including certain asset, income, distribution and stock ownership tests are met. The Company’s wholly-owned subsidiaries, CreXus S Holdings LLC, CreXus S Holdings (Grand Cayman) LLC, CreXus F Asset Holdings LLC, CHPHC Holding Company LLC, CHPHC Hotel I LLC, CHPHC Hotel II LLC, CHPHC Hotel III LLC, CHPHC Hotel IV LLC, CHPHC Hotel V LLC, CHPHC Hotel VI LLC, CHPHC Hotel VII LLC, CHPHC Hotel VIII LLC, CHPHC Hotel IX LLC, CHPHC Hotel X LLC, CHPHC Hotel XI LLC, CHPHC Hotel XII LLC, Crexus Net Lease Holdings LLC, Crexus AZ Holdings 1 LLC, Crexus NV Holdings 1 LLC, and CreXus TALF Holdings, LLC (collectively, the “Subsidiaries”), are qualified REIT subsidiaries.  The Company’s wholly-owned subsidiary, CreXus S Holdings (Holding Co) LLC, is a taxable REIT subsidiary.  Annaly Capital Management, Inc. (“Annaly”) owns approximately 12.4% of the Company’s common shares.  The Company is managed by Fixed Income Discount Advisory Company (“FIDAC”), an investment advisor registered with the Securities and Exchange Commission (“SEC”).  FIDAC is a wholly-owned subsidiary of Annaly.

2.  Summary of the Significant Accounting Policies

(a)  Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature.

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.  All intercompany balances and transactions have been eliminated.

(b) Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and in money market accounts with original maturities less than 90 days.

(c) Agency RMBS and CMBS

The Company may invest in Agency RMBS representing interests in obligations backed by pools of mortgage loans.  Agency RMBS are mortgage pass-through certificates, collateralized mortgage obligations (“CMOs”), and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans issued or guaranteed as to principal and/or interest repayment by agencies of the U.S. Government or federally chartered corporations such as Ginnie Mae, Freddie Mac or Fannie Mae.

The Company holds its Agency RMBS as available-for-sale, records investments at estimated fair value, and includes unrealized gains and losses in other comprehensive income (loss) in the consolidated statements of comprehensive income. From time to time, as part of the overall management of its portfolio, the Company may sell certain of its Agency RMBS investments and recognize a realized gain or loss as a component of earnings in the consolidated statement of comprehensive income utilizing the specific identification method.

5

Interest income on Agency RMBS is computed on the remaining principal balance of the investment security.  Premium or discount amortization/accretion on Agency RMBS is recognized over the estimated life of the investment using the effective interest method.   Changes to the Company’s assumptions subsequent to the purchase date may increase or decrease the amortization/accretion of premiums and discounts which affects interest income. Changes to assumptions that decrease expected future cash flows may result in an other-than-temporary impairment (“OTTI”).   At September 30, 2012, the Company did not own any Agency RMBS.

If at the valuation date, the fair value of an investment security is less than its amortized cost, the Company will analyze the investment security for OTTI.  Management will evaluate the Company’s CMBS and RMBS for OTTI at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  Consideration will be given to (1) the length of time and the extent to which the fair value has been lower than carrying value, (2) the intent of the Company to sell the investment prior to recovery in fair value (3) whether the Company will more likely than not be required to sell the investment before the expected recovery, and (4) the expected future cash flows of the investment in relation to its amortized cost.  If a credit portion of OTTI exists, the cost basis of the security is written down to the then-current fair value, and the related credit portion of unrealized loss is transferred from accumulated other comprehensive income (loss) as an immediate reduction of current earnings.  At September 30, 2012, the Company did not own any CMBS.

(d) Held for Investment – Loans

The Company's commercial mortgages and loans are comprised of fixed-rate and adjustable-rate loans. Mortgages and loans are designated as held for investment and are carried at their principal balance outstanding, plus any premiums or less discounts which are amortized or accreted over the estimated life of the loan, less estimated allowances for loan losses.  The difference between the face amount of a loan and proceeds at acquisition is recorded as either discount or premium. A discount or premium is also recognized for acquired loans whose coupons are not considered to reflect prevailing rates of interest for comparable loans.  In these circumstances, the Company estimates the prevailing rate of interest to maturity for a note that would have resulted between an independent borrower and lender for a similar transaction under comparable terms and conditions.

(e) Preferred Equity Interests Held for Investment

Preferred equity interests are designated as held for investment and are carried at their principal balance outstanding, plus any premiums or less any discounts which are amortized or accreted over its estimated life, less estimated allowances for losses.

(f) Investment in Real Estate and Real Estate Held for Sale

Investment in real estate is carried at historical cost less accumulated depreciation. Costs directly related to acquisitions deemed to be business combinations are expensed. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and improvements that extend the useful life of the asset are capitalized and depreciated over their useful life.

Investments in real estate are depreciated using the straight-line method over the estimated useful lives of the assets, summarized as follows:

Category	Term
Building	35-40 years
Site improvements	2-7 years

6

The Company follows the acquisition method of accounting for acquisitions of operating real estate held for investment, where the purchase price of operating real estate is allocated to tangible assets such as land, building, site improvements and other identified intangibles such as above/below market and in-place leases.

The Company evaluates whether real estate acquired in connection with a foreclosure (REO), UCC/deed in lieu of foreclosure or a consensual modification of a loan (herein collectively referred to as a foreclosure) constitutes a business and whether business combination accounting is applicable. Any excess upon foreclosure of a property between the carrying value of a loan over the estimated fair value of the property, less costs to sell, is charged to provision for loan losses.  

Investments in real estate, including REO, which have met the criteria to be classified as held for sale, are separately presented in the consolidated statements of financial condition. Such operating real estate is reported at the lower of its carrying value or its estimated fair value less the cost to sell. Once a property is determined to be held for sale, depreciation is no longer recorded. In addition, the results of operations are reclassified to income (loss) from discontinued operations in the consolidated statements of comprehensive income.

The Company's real estate portfolio (REO and real estate held for investment) is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable. A property's value is considered impaired if the Company's estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property. In conducting this review, the Company considers U.S. macroeconomic factors, including real estate sector conditions, together with asset specific and other factors. To the extent an impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.  The Company recorded an impairment of approximately $2.6 million on real estate held for sale for the quarter and nine months ended September 30, 2012, which is recorded as a component of discontinued operations.     

Allowance for doubtful accounts

Allowances for doubtful accounts for tenant receivables are established based on a periodic review of aged receivables resulting from estimated losses due to the inability of tenants to make required rent and other payments contractually due. Additionally, the Company establishes, on a current basis, an allowance for future tenant credit losses on billed and unbilled rents receivable based upon an evaluation of the collectability of such amounts.

Rental income

Rental income from investments in real estate is derived from leasing space to various types of corporate tenants. The leases are for fixed terms of varying length and provide for annual rentals to be paid in monthly installments. Rental income from leases is recognized on a straight-line basis over the term of the respective leases. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in rents receivable in the consolidated statements of financial condition.

Deferred Costs

Deferred costs include deferred financing costs and deferred lease costs and are included in other assets in the consolidated statement of financial condition. Deferred financing costs represent commitment fees, legal and other third-party costs associated with obtaining financing. These costs are amortized to interest expense over the term of the financing. Unamortized deferred financing costs are expensed when the associated borrowing is refinanced or repaid before maturity.

Identified Intangibles

The Company records acquired identified intangibles, which includes intangible assets (value of the above-market leases, and in-place leases) and intangible liabilities (value of below-market leases), based on estimated fair value. The value allocated to the above or below-market leases is amortized over the remaining lease term as a net adjustment to rental income.  Other intangible assets are amortized on a straight-line basis over the remaining lease term. Identified intangible assets are recorded in intangible assets, net and identified intangible liabilities are recorded in intangible liabilities, net on the consolidated statements of financial condition.  The weighted-average amortization period for intangible assets and liabilities is 14.3 years and 12.7 years, respectively, as of September 30, 2012.

7

The following summarizes identified intangibles as of September 30, 2012 and December 31, 2011:

	September 30, 2012								December 31, 2011
	(dollars in thousands)
	Intangible Assets Above- market Leases		Intangible Assets In- place Leases			Intangible Liabilities Below-market Leases			Intangible Assets Above- market Leases		Intangible Assets In- place Leases		Intangible Liabilities Below-market Leases
Gross amount	$	-	$	5,535		$	(2,030	)	$	-	$	-	$	-
Accumulated amortization		-		(334	)		92			-		-		-
Total	$	-	$	5,201		$	(1,938	)	$	-	$	-	$	-

The Company recorded amortization of acquired below-market leases of $31thousand and $0 for the quarters ended September 30, 2012 and 2011, respectively.  The Company recorded amortization of acquired below-market leases of $92 thousand and $0 for the nine months ended September 30, 2012 and 2011, respectively. Amortization of other intangible assets was $105 thousand, and $0 for the quarters ended September 30, 2012 and 2011, respectively.  Amortization of other intangible assets was $334 thousand, and $0 for the nine months ended September 30, 2012 and 2011, respectively.

(g) Allowance for Loan Losses and Reserve for Probable Credit Losses

The Company maintains a loan loss reserve on certain of its debt investments. A provision is established when the Company believes a loan is impaired, which is when it is deemed probable that the Company will be unable to collect principal and interest amounts due according to the contractual terms. A provision for credit losses related to loans accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30), may be established when it is probable the Company will not collect all amounts previously estimated to be collected. Management assesses the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary. Significant judgment of the Company is required in this analysis. The Company considers the estimated net recoverable value of the loan as well as other factors, including but not limited to fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized may differ materially from the carrying value as of the statement of financial condition date.

The Company’s methodology for assessing the appropriateness of the allowance for loan losses consists of, but is not limited to, evaluating each loan as follows:  the Company reviews loan to value metrics upon either the origination or the acquisition of a new asset.  The Company generally reviews the most recent financial information produced by the borrower, net operating income (“NOI”), debt service coverage ratios (“DSCR”), property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of its assets, and may consider other factors it deems important. The Company reviews market pricing to determine the ability to refinance the asset.  The Company also reviews economic trends, both macro as well as those directly affecting the property, and the supply and demand of competing projects in the sub-market in which the subject property is located. The Company also evaluates the borrower’s ability to manage and operate the properties.  The Company generally does not review loan to value metrics on a quarterly basis.

When a loan is impaired, the amount of the loss accrual is calculated by comparing the carrying amount of the investment to the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, to the value of the collateral if the loan is collateral dependent.  Interest on impaired loans is recognized when received in cash.

8

Income recognition is suspended for the loans at the earlier of the date at which payments become 90-days past due or when, in the opinion of the Company, a full recovery of income and principal becomes doubtful. Income is then recorded on a cash basis until an accrual is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. A loan is written off when it is no longer realizable and/or legally discharged.

Loans are assigned an internal rating of “Performing Loans,” “Watch List Loans” or “Workout Loans.”  Performing Loans meet all present contractual obligations.  Watch List Loans are defined as performing or nonperforming loans for which the timing of cost recovery is under review.  Workout Loans are defined as loans for which there is a likelihood that the Company may not recover its cost basis.

(h) Troubled Debt Restructuring

Real estate debt investments modified in a troubled debt restructuring ("TDR") are modifications granting a concession to a borrower experiencing financial difficulties where a lender agrees to terms that are more favorable to the borrower than is otherwise available in the current market. Management judgment is necessary to determine whether a loan modification is considered a TDR. Troubled debt that is fully satisfied via foreclosure, repossession or other transfers of assets is included in the definition of TDR. Individual, or pools of, loans acquired with deteriorated credit quality that have been modified are not considered a TDR.

(i) Revenue Recognition

Interest income is accrued based on the outstanding principal amount of the securities or loans and their contractual terms. Premiums and discounts associated with the purchase of the securities or loans are amortized into interest income over the projected lives of the securities or loans using the effective interest method based on the estimated recovery value.

The Company recognizes rental revenue on real estate on a straight-line basis over the non-cancelable term of the lease. The excess of straight-line rents over base rents under the lease is included in rents receivable on the Company’s Consolidated Statement of Financial Condition and any excess of base rents over the straight-line amount is recorded as a decrease to rents receivable on the Company’s Consolidated Statement of Financial Condition.

Fees received relating to origination of loans are included in “Other Assets” on the Company’s Consolidated Statements of Financial Condition and are amortized into “Miscellaneous fee income” over the life of the loan.

(j) Income Taxes

The Company has qualified and elected to be taxed as a REIT, and therefore it generally will not be subject to corporate federal or state income tax to the extent that the Company makes qualifying distributions to stockholders and provided the Company satisfies the REIT requirements, including certain asset, income, distribution and stock ownership tests.  If the Company fails to qualify as a REIT and does not qualify for certain statutory relief provisions, the Company would be subject to federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the REIT qualification was lost.

The provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, Income Taxes (ASC 740), clarify the accounting for uncertainty in income taxes recognized in financial statements and prescribe a recognition threshold and measurement attribute for tax positions taken or expected to be taken on a tax return. ASC 740 also requires that interest and penalties related to unrecognized tax benefits be recognized in the financial statements. The Company does not have any unrecognized tax benefits that would affect its financial position.  Thus, no accruals for penalties and interest were necessary as of September 30, 2012.

9

The Company files tax returns in several U.S. jurisdictions, including New York State, and New York City.  The 2009 through 2011 tax years remain open to U.S. federal, state and local examinations.

(k) Net Income per Share

The Company calculates basic net income per share by dividing net income for the period by the weighted-average shares of its common stock outstanding for that period.  Diluted net income per share takes into account the effect of dilutive instruments, such as stock options, but uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted average number of shares outstanding.  The Company had no potentially dilutive securities outstanding during the periods presented.

(l) Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as well as loan loss provisions.  Actual results could differ from those estimates.

(m) Derivatives

The Company uses derivative instruments primarily to manage interest rate risk exposure and such derivatives are not considered speculative.  The Company has one interest rate swap outstanding which has not been designated as a hedging instrument for accounting purposes.  Changes in the fair value of the interest rate swap are recorded in the Statements of Comprehensive Income.

(n) Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

(o) Recent Accounting Pronouncements

Presentation

Comprehensive Income (Topic 220)

In June 2011, FASB released ASU 2011-05 Comprehensive Income: Presentation of Comprehensive Income, which attempts to improve the comparability, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income (“OCI”).  ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of net income and comprehensive income or two separate consecutive statements.  Either presentation requires the presentation on the face of the financial statements any reclassification adjustments for items that are reclassified from OCI to net income in the statements.  There is no change in what must be reported in OCI or when an item of OCI must be reclassified to net income.  This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  This update resulted in additional disclosure, but had no significant effect on the Company’s consolidated financial statements.  On December 23, 2011, the FASB issued ASU 2011-12, Comprehensive Income: Deferral of Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income In ASU No. 2011-05, which defers those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated OCI.  This was done to allow the FASB time to re-deliberate the presentation on the face of the financial statements the effects of reclassifications out of accumulated OCI on the components of net income and OCI.  No other requirements under ASU 2011-05 are affected by ASU 2011-12.  During June 2012, the FASB tentatively decided not to require presentation of reclassification adjustments out of accumulated other comprehensive income on the face of the financial statements and to propose new disclosures instead.  The Company adopted ASU 2011-05 on January 1, 2012.

10

Assets

Property, Plant, and Equipment (Topic 360)

In December 2011, the FASB released ASU 2011-10, Derecognition of in Substance Real Estate—a Scope Clarification.  The amendments in ASU 2011-20 provide that when a parent (reporting entity) ceases to have a controlling financial interest (as described in Subtopic 810-10) in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary’s operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt.  ASU 2011-10 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after June 15, 2012.  The adoption of ASU 2011-10 is not expected to have a material impact on the consolidated financial statements.

Broad Transactions

Fair Value Measurements and Disclosures (Topic 820)

In May 2011, the FASB released ASU 2011-04 Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, further converging US GAAP and International Financial Reporting Standards (“IFRS”) by providing common fair value measurement and disclosure requirements.  FASB made changes to the fair value measurement guidance, which include: 1) Prohibiting the inclusion of block discounts in all fair value measurements, not just Level 1 measurements 2) Adding guidance on when to include other premiums and discounts in fair value measurements  3) Clarifying that the concepts of “highest and best use” and “valuation premise” apply only when measuring the fair value of non-financial assets, and 4) Adding an exception that allows the measurement of a group of financial assets and liabilities with offsetting risks (e.g., a portfolio of derivative contracts) at their net exposure to a particular risk if certain criteria are met.  ASU 2011-04 also requires additional disclosure related to items categorized as Level 3 in the fair value hierarchy, including a description of the processes for valuing these assets, providing quantitative information about the significant unobservable inputs used to measure fair value, and in certain cases, explain the sensitivity of the fair value measurements to changes in unobservable inputs.  This guidance is effective for interim and annual reporting periods beginning after December 15, 2011.  This update resulted in additional disclosures in the notes to the consolidated financial statements.

Transfers and Servicing (Topic 860)

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing: Reconsideration of Effective Control for Repurchase Agreements.  In a typical repurchase agreement transaction, an entity transfers financial assets to the counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future.  Previous to this update, one of the factors in determining whether sale treatment could be used was whether the transferor maintained effective control of the transferred assets and in order to do so, the transferor must have the ability to repurchase such assets. In connection with the issuance of ASU 2011-03, the FASB concluded that the assessment of effective control should focus on a transferor’s contractual rights and obligations with respect to transferred financial assets, rather than whether the transferor has the practical ability to perform in accordance with those rights or obligations.  ASU 2011-03 removes the transferor’s ability criterion from consideration of effective control.  This update is effective for the first interim or annual period beginning on or after December 15, 2011 and did not have a material impact on the consolidated financial statements.

11

Financial Services – Investment Companies (Topic 946)

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

3. Cash and Cash Equivalents

The Company had $105.6 million and $202.8 million of cash equivalents held at independent national banking institutions at September 30, 2012 and December 31, 2011, respectively, and earned $1 thousand and $12 thousand in interest income on the Company’s cash balances for the quarters ended September 30, 2012 and December 31, 2011, respectively.

4.  Commercial Real Estate Loans Held for Investment

The following table represents the Company's commercial mortgage loans classified as held for investment at September 30, 2012 and December 31, 2011, which are carried at their principal balance outstanding, net of any related premium or discount, less an allowance for loan losses:

	September 30, 2012							December 31, 2011
					Percentage							Percentage
	Outstanding		Carrying		of Loan			Outstanding		Carrying		of Loan
	Principal		Value		Portfolio(1)			Principal		Value		Portfolio(1)
	(dollars in thousands)
First mortgages	$	146,975	$	146,437		19.9	%	$	439,795	$	374,348		52.5	%
Subordinate notes		41,495		38,837		5.6	%		79,279		71,517		9.5	%
Mezzanine loans		551,246		546,541		74.5	%		317,915		306,936		38.0	%
Total	$	739,716	$	731,815		100.0	%	$	836,989	$	752,801		100.0	%
(1) Based on outstanding principal.

The following table represents a summary of the changes in the carrying value of the Company’s commercial mortgage loans held for investment for the nine months ended September 30, 2012 and September 30, 2011, respectively:

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	September 30, 2012												September 30, 2011
	First			Subordinate			Mezzanine						First			Subordinated			Mezzanine
	Mortgages			Notes			Loans			Total			Mortgages			Notes			Loans			Total
	(dollars in thousands)
Beginning principal balance, net of allowance for loan losses	$	439,712		$	79,208		$	317,697		$	836,617		$	38,152		$	42,007		$	95,109		$	175,268
Purchases, principal balance		46,500			8,501			299,172			354,173			529,899			65,738			362,936		$	958,573
Remaining discount		(538	)		(2,658	)		(4,704	)		(7,900	)		(92,469	)		(9,895	)		(10,520	)	$	(112,884	)
Principal payments		(218,325	)		(15,113	)		(54,842	)		(288,280	)		(135,691	)		(26,786	)		(169,062	)	$	(331,539	)
Principal write-off		(36,396	)		(6,405	)		(11,000	)		(53,801	)		(16,002	)		-			-		$	(16,002	)
Sales		(50,000	)		-			-			(50,000	)		-			-			-			-
Transfers to real estate held for sale		(34,595	)		(24,768	)		-			(59,363	)		-			-			-			-
		146,358			38,765			546,323			731,446			323,889			71,064			278,463			673,416
Recovery (allowance) for loan losses		79			72			218			369			(40	)		(23	)		(44	)		(107	)
Commercial mortgage loans held for investment	$	146,437		$	38,837		$	546,541		$	731,815		$	323,849		$	71,041		$	278,419		$	673,309

At September 30, 2012 the Company had one loan that was to be accounted for pursuant to ASC Subtopic 310-30.  This loan was originally recorded at cost, which approximated fair value at the time of purchase.  The principal balance at September 30, 2012 was $43.4 million.  At December 31, 2011 the principal balance of loans recorded under Subtopic ASC 310-30 was $315.6 million.

The following table presents the accretable yield, or the amount of discount estimated to be realized over the life of the loans and the carrying value, related to the Company’s commercial real estate loan portfolio for the nine months ended September 30, 2012 and 2011, respectively, which were accounted for pursuant to ASC Subtopic 310-30:

	Accretable Yield
	September 30, 2012						September 30, 2011
	Accretable Yield			Carrying Value of the Loans			Accretable Yield			Carrying Value of the Loans
	(dollars in thousands)
Beginning balance	$	13,259		$	257,065		$	-		$	-
Additions		-			-			50,581			296,949
Accretion		(9,200	)		9,200			(13,120	)		13,120
Collections		-			(169,000	)		-			(73,048	)
Disposition/transfers		(1,126	)		(53,865	)		-			-
Decrease in cashflow estimates		(2,933	)		-			-			-
Reclassifications from nonaccretable
difference		-			-			4,554			-
Ending balance	$	-		$	43,400		$	42,015		$	237,021

The following table summarizes the changes in the allowance for loan losses for the commercial mortgage loan portfolio for the nine months ended September 30, 2012 and 2011, respectively.

13

	September 30, 2012			September 30, 2011
	(dollars in thousands)
Balance, beginning of period	$	369		$	224
Reversal		(369	)		-
Provision for loan loss		3,172			107
Charge-offs		(3,172	)		-
Balance, end of period	$	-		$	331

The following tables present certain characteristics of the Company’s commercial mortgage loan portfolio as of September 30, 2012 and December 31, 2011, respectively.

September 30, 2012
Geographic Distribution						Property
Top 5 States	Remaining Balance		% of Loans (1)			Count
		(dollars in thousands)
Texas	$	153,894		20.8	%		104
Illinois		87,471		11.8	%		96
New York		76,893		10.4	%		8
Georgia		55,362		7.5	%		50
California		51,522		7.0	%		71
December 31, 2011
Geographic Distribution						Property
Top 5 States	Remaining Balance		% of Loans (1)			Count
		(dollars in thousands)
New York	$	215,337		25.7	%		25
California		195,401		23.3	%		83
Texas		79,717		9.5	%		59
Georgia		68,060		8.1	%		6
Illinois		54,512		6.5	%		75

(1)  Percentages based on remaining principal balance of the debt portfolio of $739.7 million and $837.0 million as of September 30, 2012 and December 31, 2011, respectively.

14

September 30, 2012
Property Type	Number of Assets		Outstanding Principal		% of Total
	(dollars in thousands)
Retail		9	$	265,071		36	%
Office		11		237,256		32	%
Hotel		5		125,400		17	%
Industrial		3		96,500		13	%
Condominium		2		15,489		2	%
Total		30	$	739,716		100	%
December 31, 2011
Property Type	Number of Assets		Outstanding Principal		% of Total
	(dollars in thousands)
Hotel		9	$	343,606		41	%
Office		14		174,621		21	%
Retail		6		160,662		19	%
Multi-family		2		132,000		16	%
Condominium		2		26,100		3	%
Total		33	$	836,989		100	%

On a quarterly basis, the Company evaluates the adequacy of its allowance for loan losses.  Based on this analysis, the Company determined that no loan loss provision is necessary as of the quarter ended September 30, 2012. At December 31, 2011 the Company had an allowance for loan losses of approximately $369 thousand.   At September 30, 2012, two loans with a combined carrying value of approximately $57.0 million were designated as Watch List loans.  There was no provision for loan losses at September 30, 2012.

15

The following tables present the loan type and internal rating for the loans as of September 30, 2012 and December 31, 2011.

September 30, 2012
			Percentage			Internal Ratings
	Outstanding		of Loan			Performing		Watch List		Workout
Investment type	Principal		Portfolio			Loans		Loan		Loan
	(dollars in thousands)
First mortgages	$	146,975		19.9	%	$	134,002	$	12,973	$	-
Subordinate notes		41,495		5.6	%		41,495		-		-
Mezzanine loans		551,246		74.5	%		507,246		44,000		-
	$	739,716		100.0	%	$	682,743	$	56,973	$	-
December 31, 2011
			Percentage			Internal Ratings
	Outstanding		of Loan			Performing		Watch List		Workout
Investment type	Principal		Portfolio			Loans		Loans		Loans
	(dollars in thousands)
First mortgages	$	439,795		52.5	%	$	398,815	$	-	$	40,980
Subordinate notes		79,279		9.5	%		56,608		-		22,671
Mezzanine loans		317,915		38.0	%		317,915		-		-
	$	836,989		100.0	%	$	773,338	$	-	$	63,651

5. Preferred Equity Held for Investment

The following table represents the Company's preferred equity classified as held for investment at September 30, 2012 and December 31, 2011, which are carried at their principal balance outstanding less an allowance for loan losses:

	September 30, 2012		December 31, 2011
	(dollars in thousands)
Beginning balance	$	-	$	22,700
Purchases, principal balance		39,769		-
Principal payments		-		(22,718	)
Less: allowance for loan losses		-		(20	)
Recovery		-		38
Preferred equity held for investment
	$	39,769	$	-

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The following table summarizes the changes in the allowance for loan losses for the preferred equity for the nine months ended September 30, 2012 and 2011:

	Nine Months Ended
	September 30, 2012		September 30, 2011
	(dollars in thousands)
Balance, beginning of period	$	-	$	18
Provision for loan loss		-		20
Balance, end of period	$	-	$	38

The Company’s preferred equity portfolio had a principal balance outstanding of $39.8 million as of September 30, 2012, that consisted of one investment secured by the equity in ten multifamily properties located in the suburban Baltimore and Washington, D.C. area.  The Company had no preferred equity investments at December 31, 2011.

6. Investment in Real Estate, Net and Real Estate Held for Sale

At September 30, 2012 and December 31, 2011, investment in real estate, net consists of the following:

	As of
	September 30, 2012			December 31, 2011
	(dollars in thousands)
Land	$	7,490		$	7,289
Buildings and improvements		27,306			25,961
Subtotal		34,796			33,250
Less: Accumulated depreciation		(870	)		(54	)
Investments in real estate, net	$	33,926		$	33,196

For the quarters ended September 30, 2012 and 2011, depreciation expense was $271 thousand, and $0, respectively.  For the nine months ended September 30, 2012, and 2011, depreciation expense was $816 thousand, and $0, respectively.  

Real Estate Acquisitions

For the nine months ended September 30, 2012 the Company finalized the purchase price allocation related to the following real estate acquisitions:

Date of acquisition	Type	Location	Purchase Price
			(dollars in thousands)
November 2011	Warehouse/distribution center	Phoenix, AZ	$	33,250
February 2012	Warehouse	Las Vegas, NV		5,050
			$	38,300

The Company has estimated the fair value of the assets and liabilities at the date of acquisition.  The allocation of the purchase price for the warehouse/distribution center in Phoenix was finalized during the quarter ended March 31, 2012 and resulted in the Company recording $5.2 million in intangible assets and $1.6 million of intangible liabilities.  In connection with the acquisition of the warehouse in Nevada during the quarter ended March 31, 2012, the Company recorded $318 thousand in intangible assets and $421 thousand of intangible liabilities.  The Company did not acquire real estate during the quarter ended September 30, 2012.

17

The supplemental unaudited pro forma financial information set forth below is based upon the Company's historical consolidated statements of comprehensive income for the quarters and  nine months ended September 30, 2012, and 2011, adjusted to give effect to the above transactions as of January 1, 2011.

	Business Combinations Actual				Pro Forma Consolidated
	For the quarter ended		For the nine months ended		For the quarter ended				For the nine months ended
	September 30, 2012				September 30, 2012		September 30, 2011		September 30, 2012		September 30, 2011
	(dollars in thousands, except per share data)
Pro forma revenues	$	809	$	2,332	$	27,440	$	44,966	$	69,157	$	78,106
Pro forma net (loss) income	$	2	$	235	$	22,628	$	39,938	$	53,149	$	67,010
Pro forma net income per common share - basic/diluted	$	0.00	$	0.00	$	0.30	$	0.52	$	0.69	$	1.16

The supplemental pro forma financial information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the transaction occurred January 1, 2011, nor does it purport to represent the results of future operations.

For the nine months ended September 30, 2012, the Company acquired the following real estate in connection with a deed-in-lieu of foreclosure (amounts in thousands):

Date	Type	Location	Carrying Value of Loan at Time of REO
			(dollars in thousands)
February 2012	Hotels	Various	$	55,973

Real estate acquired via deed in lieu of foreclosure during the nine months ended September 30, 2012 is classified as assets held for sale as of September 30, 2012, and is unencumbered by contractual debt obligations.  The working capital related to assets classified as held for sale is comprised of $5.7 million in current assets and $2.6 million in current liabilities as of September 30, 2012.  The net working capital of $3.1 million is included in other assets in the consolidated statement of financial condition.  The Company had no assets classified as real estate held for sale at December 31, 2011.  

During the nine months ended September 30, 2012, the Company recognized a $3.2 million provision for loan loss in connection with taking possession of the collateral underlying loans via a deed in lieu of foreclosure.

Discontinued Operations

The following table summarizes income from discontinued operations, which represents the income from the operations of the properties held for sale, for the quarter and nine months ended September 30, 2012:

18

	Quarter ended September 30, 2012		Nine months ended September 30, 2012
Revenue:	(dollars in thousands)
Operating income	$	7,415	$	20,789
Expenses:
Property operating expenses		4,087		14,126
Pretax earnings		3,328		6,663
Income tax		425		2,284
Total income from discontinued operations	$	2,903	$	4,379

During the quarter ended September 30, 2012 the Company recognized an approximate $2.6 million impairment charge related to one of the assets held for sale.  The impairment charge is measured as the excess of the carrying value of the individual asset over the anticipated sale price.  The anticipated sale price is based on an executed purchase and sale agreement.

The Company had no discontinued operations for the quarter ended September 30, 2011.

Disposition of Assets held for sale

No sales occurred during the quarter ended September 30, 2012.  During the nine months ended September 30, 2012, the Company sold two hotels resulting in net proceeds of approximately $10.5 million.  The sales transactions resulted in pre-tax gains approximating $1.8 million for the nine months ended September 30, 2012, which are recorded as a gain on sale from discontinued operations.  No sales occurred during the quarter and nine months ended September 30, 2011.

7.  Fair Value Measurements

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

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

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

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

The following describes the methodologies utilized by the Company to estimate the fair value of its financial instruments by instrument class.

19

Short-term Instruments

The carrying value of cash and cash equivalents, accrued interest receivable, dividends payable, accounts payable and other liabilities, and accrued interest payable generally approximates estimated fair value due to the short term nature of these financial instruments.

CMBS and Agency RMBS

All assets classified as available-for-sale are reported at their estimated fair value, based on market prices.  The Company determines the fair value of its investment securities utilizing a pricing model that incorporates such factors as coupon, prepayment speeds, weighted average life, collateral composition, borrower characteristics, expected interest rates, life caps, periodic caps, reset dates, collateral seasoning, expected losses, expected default severity, credit enhancement, and other pertinent factors.  Management will review the fair values generated by the model to determine whether prices are reflective of the current market.  Management will perform a validation of the fair value calculated by the internal pricing model by comparing its results to one or more independent prices provided by dealers in the securities and/or third party pricing services.

If dealers or independent pricing services are unable to provide a price for an asset or if the Company deems the price provided by such dealers or independent pricing services to be unreliable, then the Company will determine the fair value of the asset in good faith.  In addition, validating third party pricing for the Company’s investments may be more subjective as fewer participants may be willing to provide this service to the Company.  Illiquid investments typically experience greater price volatility as a ready market does not exist.  As fair value is not an entity specific measure and is a market based approach which considers the value of an asset or liability from the perspective of a market participant, observability of prices and inputs can vary significantly from period to period.  A condition such as this can cause instruments to be reclassified from Level 2 to Level 3 when the Company is unable to obtain third party pricing verification.

Repurchase Agreements

The Company records repurchase agreements at their contractual amounts including accrued interest payable.  Repurchase agreements are collateralized financing transactions utilized by the Company to acquire investment securities.  Due to the short term nature of these financial instruments, the Company estimated the fair value of these repurchase agreements to be the contractual obligation plus accrued interest payable at maturity.

Interest Rate Swaps

Interest rate swaps are valued using internal pricing models that are corroborated using third party quotes.  The Company incorporates common market pricing methods, including a spread measurement to the Treasury curve in its estimates of fair value.  Management ensures that current market conditions are reflected in its estimates of fair value. 

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

	September 30, 2012
	Level 1		Level 2		Level 3
	(dollars in thousands)
Liabilities:
Interest Rate Swap	$	-	$	100	$	-

The Company had no financial assets or liabilities carried at fair value on a recurring basis at December 31, 2011.

Financial Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis

GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the financial statements, for which it is practical to estimate the value. In cases where quoted market prices are not available, fair values are based upon the estimation of discount rates to estimated future cash flows using market yields or other valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, fair values are not necessarily indicative of the amount the Company could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts.

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Commercial real estate loan assets totaled $731.8 million and $752.8 million at September 30, 2012 and December 31, 2011, respectively.  These loans are held for investment and are recorded at amortized cost less an allowance for loan losses. The estimated fair value of these loans is $750.2 million as of September 30, 2012.  Such estimates take into consideration expected changes in interest rates and changes in the underlying collateral cash flows.  The fair value of commercial real estate loans is based on the loan’s contractual cash flows and estimated changes in the yield curve.  The fair value also reflects consideration of changes in credit risk since the loan was originated.

Preferred equity investments totaled $39.8 million at September 30, 2012.  The Company held no preferred equity investments at December 31, 2011.  The preferred equity investment is recorded at amortized cost less an allowance for loan losses. The estimated fair value of this investment is $39.6 million as of September 30, 2012.The fair value of preferred equity is based on the underlying cash flows and estimated changes in the yield curve.  The fair value also reflects consideration of changes in credit risk since the time of initial investment.

The carrying value of participations sold is based on the loan’s amortized cost.  The fair value of participations sold is based on the fair value of the underlying related commercial loan.

Mortgages payable totaled $19.2 million at September 30, 2012.  The carrying value of the Company’s mortgage loans are considered to approximate their fair value as a result of the recent issuance of the debt obligations.

The following table summarizes the estimated fair value for all financial assets and liabilities as of September 30, 2012 and December 31, 2011.

		September 30, 2012				December 31, 2011
		Carrying Value		Fair Value		Carrying Value		Fair Value
	Level in Fair	(dollars in thousands)
Financial assets:	Value Hierarchy
Cash and cash equivalents(1)	1	$	105,575	$	105,575	$	202,814	$	202,814
Commercial real estate investments:
Senior	3		146,437		149,188		374,348		379,877
Subordinate	3		38,837		42,331		71,517		76,115
Mezzanine	3		546,541		558,670		306,936		316,157
Preferred equity	3		39,769		39,553		-		-
Financial liabilities:
Mortgage payable	2		19,150		19,150		16,600		16,600
Participations sold	3		-		-		14,755		14,755
Interest rate swap liability	2		100		100		-		-
(1)Carrying value approximates fair value due to the short-term maturities of these items.

Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value assumptions.

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Nonfinancial Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis

Real estate held for sale totaled $41.5 million at September 30, 2012 and is recorded at its estimated fair value less costs to sell (considered to be Level 3 in the fair value hierarchy).  The estimated fair value is based on the property's future discounted cash flows to be generated using discount rates ranging from 12% to 13.5% and terminal cap rates ranging from 10.0% to 10.5%, sales comparables, or the expected sales price based on an executed purchase and sale agreement. Estimates of fair value take into consideration U.S. macroeconomic factors, including real estate sector conditions, together with asset specific and other factors.

Transfers in and out of Level 3 for the nine months ended September 30, 2012 and the year ended December 31, 2011 totaled $52.8 million and $0, respectively, and relate to real estate held for sale.

8.  Income Taxes

For the period ended September 30, 2012 the Company is qualified to be taxed as a REIT.  As a REIT, the Company is not subject to federal income tax to the extent that it distributes its taxable income to its shareholders.  To maintain qualification as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to its shareholders and meet certain other requirements including certain asset, income and stock ownership tests. It is generally the Company’s policy to distribute to its shareholders all of the Company’s taxable income.  It is assumed that the Company will retain its REIT status by complying with the REIT regulations and its distribution policy in the future. The state and city tax jurisdictions for which the Company is subject to tax filing obligations recognize the Company’s status as a REIT.  In December of 2011, the Company created a taxable REIT subsidiary (TRS) to hold those assets which represent non-qualified REIT assets.

During the quarter and nine months ended September 30, 2012, the Company recorded estimated federal and state income tax expense related to earnings of its TRS in the amount of $425 thousand  and $2.3 million, respectively, that is primarily attributable to income from discontinued operations of hotels.  This amount is recorded as a component of net income from discontinued operations in the accompanying consolidated statement of comprehensive income.

The Company files tax returns in several U.S. jurisdictions, including New York State and New York City.  The 2009 through 2011 tax years remain open to U.S. federal, state and local tax examinations.

9.  Common Stock

During the quarter ended September 30, 2012, the Company declared dividends to common shareholders totaling $24.5 million or $0.32 per share which was paid to shareholders on October 25, 2012.  During the quarter ended September 30, 2011, the Company declared dividends to common shareholders totaling $23.0 million or $0.30 per share.

During the nine months ended September 30, 2012, the Company declared dividends to common shareholders totaling $65.9 million or $0.86 per share of which $24.5 million or $0.32 per share was paid to shareholders on October 25, 2012.  During the nine months ended September 30, 2011, the Company declared dividends to common shareholders totaling $46.3 million or $0.78 per average share of which $23.0 or $0.30 per share was paid to shareholders on October 27, 2011.

10.  Equity Incentive Plan

The Company has adopted an equity incentive plan to provide incentives to our independent directors, employees of FIDAC and its affiliates, including Annaly, and other service providers to stimulate their efforts toward our continued success, long-term growth and profitability and to attract, reward and retain personnel.  The equity incentive plan is administered by the compensation committee of the board of directors.  Unless terminated earlier, the equity incentive plan will terminate in 2019, but will continue to govern unexpired awards.  The equity incentive plan provides for grants of restricted common stock and other equity-based awards up to an aggregate amount, at the time of the award, of (i) 2.5% of the issued and outstanding shares of the Company’s common stock less (ii) 250,000 shares, subject to an aggregate ceiling of 25,000,000 shares available for issuance under the plan.

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11.  Debt Obligations

The Company has two first mortgages outstanding with aggregate principal balances as of September 30, 2012 and December 31, 2011 as follows:

				Outstanding Balance
Maturity	Type	Fixed interest rate/spread over 1 Month LIBOR (1)		September 30, 2012		December 31, 2011
				(dollars in thousands)
2016	Fixed		3.50	$	16,600	$	16,600
2017 (2)	Variable		2.24		2,550		-
				$	19,150	$	16,600
(1) Applicable for variable rate loans
(2) The Company has entered into an interest rate swap to hedge against increases in interest rates. Refer to footnote 15 for more detail.

Interest expense relating to the mortgages payable, including amortized mortgage costs and the effect of the interest rate swap associated with one loan, for the quarter and nine months ended September 30, 2012 was $187 thousand and $581 thousand, respectively.

12.  Management Agreement and Related Party Transactions

The Company has entered into a management agreement with FIDAC, a wholly owned subsidiary of Annaly, which provides for an initial term through December 31, 2013 with an automatic one year extension option and is subject to certain termination rights.  The Company pays FIDAC a quarterly management fee equal to 1.50% per annum of its stockholders’ equity which is the sum of net proceeds from any issuance of the Company’s equity securities since inception, consolidated retained earnings (excluding non-cash equity compensation), any amount the Company pays for repurchases of its common stock, and less any unrealized gains, or losses or other items that do not affect realized income, as adjusted to exclude one-time events pursuant to changes in GAAP and certain non-cash charges of the Company.  Management fees accrued and subsequently paid to FIDAC were $3.4 million for the quarters ended September 30, 2012 and 2011.  Management fees accrued and subsequently paid to FIDAC were $10.3 million and $7.4 million for the nine months ended September 30, 2012 and 2011.

Upon termination without cause, the Company will pay FIDAC a termination fee.  The Company may also terminate the management agreement with 30-days prior notice from the Company’s board of directors, without payment of a termination fee, for cause, which is defined as: (i) FIDAC, its agents or its assignees materially breaching any provision of the management agreement and such breach continuing for a period of thirty (30) days after written notice thereof specifying such breach and requesting that the same be remedied in such 30-day period (or forty-five (45) days after written notice of such breach if FIDAC takes steps to cure such breach within thirty (30) days of the written notice), (ii) FIDAC engaging in any act of fraud, misappropriation of funds, or embezzlement against the Company or any subsidiary, or (iii) an event of any gross negligence on the part of FIDAC in the performance of its duties under the management agreement, or upon a change of control, which is defined as (i) the sale, lease or transfer, in one or a series of related transactions, of all or substantially all of the assets of FIDAC, taken as a whole, or Annaly, taken as a whole, to any person other than Annaly (in the case of FIDAC) or any of its respective affiliates; or (ii) the acquisition by any person or group (within the meaning of Section 13(d)(3) or Section 14(d)(2) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or any successor provision), including any group acting for the purpose of acquiring, holding or disposing of securities (within the meaning of Rule 13d-5(b)(1) under the Exchange Act), other than Annaly or any of its respective affiliates, in a single transaction or in a related series of transactions, by way of merger, consolidation or other business combination or purchase of beneficial ownership (within the meaning of Rule 13d-3 under the Exchange Act, or any successor provision) of 50% or more of the total voting power of the voting capital interests of FIDAC or Annaly.  FIDAC may terminate the management agreement if the Company or any of its subsidiaries become required to register as an investment company under the Investment Company Act of 1940, as amended, or the 1940 Act, with such termination deemed to occur immediately before such event, in which case the Company would not be required to pay a termination fee.  FIDAC may also decline to renew the management agreement by providing the Company with 180-days written notice, in which case the Company would not be required to pay a termination fee.

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The Company is obligated to reimburse FIDAC for its costs incurred under the management agreement.  In addition, the management agreement permits FIDAC to require the Company to pay for its pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of FIDAC incurred in the operation of the Company.  These expenses are allocated between FIDAC and the Company based on the ratio of the Company’s proportion of gross assets compared to all remaining gross assets managed by FIDAC as calculated at each quarter end.   FIDAC and the Company will modify this allocation methodology, subject to the Company’s board of directors’ approval if the allocation becomes inequitable (i.e., if the Company becomes very highly leveraged compared to FIDAC’s other funds and accounts).  FIDAC has waived its right to request reimbursement from the Company of these expenses until such time as it determines to rescind that waiver.

As of September 30, 2012 Annaly owned approximately 12.4% of the Company’s outstanding shares as an equity investment.

The Company uses RCap Securities, Inc. (“RCap”), a SEC registered broker-dealer and a wholly-owned subsidiary of Annaly, to settle trades.  RCap receives customary, market-based fees and charges in return for such services.   For the quarter ended September 30, 2012 the Company paid RCap approximately $9 thousand for its services.

13.  Commitments and Contingencies

From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of business.  In the opinion of management, the ultimate disposition of these matters will not have a material effect on the Company’s consolidated financial statements and therefore no accrual is required as of September 30, 2012 and 2011.

The Company agreed to pay the underwriters of its initial public offering $0.15 per share for each share sold in the initial public offering if during any full four calendar quarter period during the 24 full calendar quarters after the consummation of the initial public offering our Core Earnings (as described below) for any such four-quarter period exceeds an 8% performance hurdle rate (as described below).  The performance hurdle rate is met if during any full four calendar quarter period during the 24 full calendar quarters after the consummation of the Company’s initial public offering its Core Earnings for any such four-quarter period exceeds the product of (x) the weighted average of the issue price per share of all public offerings of its common stock, multiplied by the weighted average number of shares outstanding (including any restricted stock units, any restricted shares of common stock and any other shares of common stock underlying awards granted under our equity incentive plans) in such four-quarter period and (y) 8%.  Core Earnings is a non-GAAP measure and is defined as GAAP net income (loss) excluding non-cash equity compensation expense, depreciation and amortization (to the extent that the Company forecloses on any properties underlying our target assets), any unrealized gains, losses or other non-cash items recorded for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between FIDAC and the Company’s independent directors and after approval by a majority of the Company’s independent directors.  During the quarter ended September 30, 2012 the Company paid the underwriters $2.0 million, representing the full amount due, as a result of meeting the required hurdle.

14.  Participations Sold

Participations sold represent interests in loans that we purchased and subsequently sold to third-parties. We present these participations sold as both assets and non-recourse liabilities because these arrangements do not qualify as sales under GAAP. Generally, participations sold are recorded as assets and liabilities in equal amounts on our consolidated statements of financial condition, and an equivalent amount of interest income and interest expense is recorded on our consolidated statements of comprehensive income. However, impaired loan assets must be reduced through the provision for loans losses while the associated non-recourse liability cannot be reduced until the participation has been contractually extinguished.  This can result in a difference between the loan participations sold asset and liability.  We have no economic exposure to these liabilities.

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The loan related to the remaining participation sold was repaid during the nine months ended September 30, 2012.  The following table describes our participations sold assets and liabilities as of September 30, 2012 and December 31, 2011:

	September 30, 2012		December 31, 2011
	(dollars in thousands)
Participations sold assets
Gross carrying value	$	-	$	14,755
Less: Provision for loan losses		-		-
Net book value of assets	$	-	$	14,755
Liabilities
Net book value of liabilities	$	-	$	14,755
Net impact to shareholders' equity	$	-	$	-

15. Risk Management and Derivative Activities

Derivatives

The Company uses derivative instruments primarily to manage interest rate risk exposure and such derivatives are not considered speculative. These derivative instruments are strictly in the form of interest rate swap agreements and the primary objective is to minimize interest rate risks associated with the Company's investment and financing activities. The counterparties of these arrangements are financial institutions with which the Company may also have other financial relationships. The Company is exposed to credit risk in the event of non-performance by these counterparties and it monitors their financial condition; however, the Company currently does not anticipate that any of the counterparties will fail to meet their obligations.  

As of September 30, 2012, the Company had one interest rate swap outstanding which has not been designated as a hedging instrument for accounting purposes.  As of December 31, 2011, the Company had no interest rate swaps outstanding.

The following table presents the fair value of the Company's derivative instrument, its classification on the consolidated statements of financial condition and the consolidated statement of comprehensive income as of September 30, 2012, and the amount of income (expense) recognized during the quarter ended September 30, 2012:

	Location in Consolidated Statements of Financial Condition	Location in Consolidated Statements of Operations and Comprehensive Income (Loss)	Notional Amount		Fair Value Net Asset (Liability)			Interest Income (Expense) on Interest Rate Swaps			Unrealized Gains (Losses) on Interest Rate Swaps
	(dollars in thousands)
September 30, 2012	Accounts payable and other liabilities	Interest Expense		2,550		(100	)		(20	)		(100	)

The Company's counterparties held no cash margin as collateral against the Company's derivative contracts as of September 30, 2012 and December 31, 2011.

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Credit Risk Concentrations

Concentrations of credit risk arise when a number of borrowers, tenants, operators or issuers related to the Company's investments are engaged in similar business activities or located in the same geographic location to be similarly affected by changes in economic conditions. The Company monitors its portfolio to identify potential concentrations of credit risks. The Company has no one borrower, tenant or operator that generates 10% or more of its total revenue.

16. Stockholders' Equity

Earnings Per Share

Earnings per share for the three and nine months ended September 30, 2012 and 2011, respectively, is computed as follows:

	Quarter ended September 30, 2012		Quarter ended September 30, 2011		Nine months ended September 30, 2012		Nine months ended September 30, 2011
	(dollars in thousands)				(dollars in thousands)
Numerator:
Net income	$	22,628	$	39,936	$	53,126	$	66,622
Effect of dilutive securities:		-		-		-		-
Dilutive net income  available to stockholders	$	22,628	$	39,936	$	53,126	$	66,622
Denominator:
Average shares available to common stockholders		76,630,528		76,620,112		76,625,054		57,887,511
Weighted Average Dilutive Shares		-		-		-		-
Net income  per average share attributable to common stockholders - Basic/Diluted	$	0.30	$	0.52	$	0.69	$	1.15

17. Segment Reporting

ASC 280, Segment Reporting (ASC 280), establishes the manner in which public entities report information about operating segments in annual and interim financial reports issued to shareholders.  ASC 280 defines a segment as a component of an enterprise about which separate financial information is available and that is evaluated regularly to allocate resources and assess performance. The Company conducts its business through two segments: debt investments and investment in real estate. For segment reporting purposes, the Company does not allocate interest income on short-term investments or general and administrative expenses.  The quarter ended December 31, 2011 is the first quarter the Company was required to report more than one segment due to the purchase of two warehouse and distribution facilities in Arizona.  Below are the operating results for the quarters and nine months ended September 30, 2012 and 2011, respectively.

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	For the Quarter Ended September 30, 2012
	Corporate/ Unallocated			Debt Investments			Real Estate Investments			Inter-segment Transactions			Consolidated Total
	(dollars in thousands)
Net interest income:
Interest income	$	-		$	27,387		$	-		$	(546	)	$	26,841
Interest expense		-			-			(187	)		-			(187	)
Servicing fees		-			(144	)		(5	)		-			(149	)
Net interest income		-			27,243			(192	)		(546	)		26,505
Other income:
Realized loss on sale of loan		-			-			-			-			-
Miscellaneous fee income		-			126			-			-			126
Rental income		-			-			809			-			809
Total other income		-			126			809			-			935
Other expenses:
Management fees to affiliate		3,446			-			-			-			3,446
General and administrative expenses		928			35			364			-			1,327
Amortization Expense		-			-			105			-			105
Depreciation expense		-			-			271			-			271
Total other expenses		4,374			35			740			-			5,149
Net (loss) income before income tax		(4,374	)		27,334			(123	)		(546	)		22,291
Income tax		-			-			6			-			6
(Loss) income from continuing operations		(4,374	)		27,334			(129	)		(546	)		22,285
Net income from discontinued operations (net of tax expense of $425)		-			-			2,357			546			2,903
Gain on sale from discontinued operations		-			-			-			-			-
Impairment charges								(2,560	)					(2,560	)
Total (loss) income from discontinued operations		-			-			(203	)		546			343
Net (loss) income	$	(4,374	)	$	27,334		$	(332	)	$	-		$	22,628
Total assets	$	873		$	926,830		$	93,498		$	(52,789	)	$	968,412
	For the Quarter Ended September 30, 2011
	Corporate/ Unallocated			Debt Investments			Real Estate Investments			Inter-segment Transactions			Consolidated Total
	(dollars in thousands)
Net interest income:
Interest income	$	-		$	44,174		$	-		$	-		$	44,174
Interest expense		-			(21	)		-			-			(21	)
Servicing fees		-			(213	)		-			-			(213	)
Net interest income		-			43,940			-			-			43,940
Other income:
Miscellaneous fee income		-			217			-			-			217
Total other income		-			217			-			-			217
Other expenses:
Management fees to affiliate		3,373			-			-			-			3,373
General and administrative expenses		842			6			-			-			848
Total other expenses		4,215			6			-			-			4,221
Net (loss) income before income tax		(4,215	)		44,151			-			-			39,936
Income tax		-			-			-			-			-
Net (loss) income	$	(4,215	)	$	44,151		$	-		$	-		$	39,936
Total assets	$	788		$	946,207		$	-		$	-		$	946,995

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	For the Nine Months Ended September 30, 2012
	Corporate/ Unallocated			Debt Investments			Real Estate Investments			Inter-segment Transactions			Consolidated Total
	(dollars in thousands)
Net interest income:
Interest income	$	-		$	69,881		$	-		$	(2,136	)	$	67,745
Interest expense		-			(276	)		(581	)		-			(857	)
Servicing fees		-			(366	)		(12	)	$	-			(378	)
Net interest income		-			69,239			(593	)		(2,136	)		66,510
Other income:
Realized loss on sale of loan		-			(525	)		-			-			(525	)
Miscellaneous fee income		-			768			-			-			768
Rental income		-			-			2,332			-			2,332
Total other income		-			243			2,332			-			2,575
Other expenses:
Provision loan losses, net		-			(369	)		3,172			-			2,803
Management fees to affiliate		10,343			-			-			-			10,343
General and administrative expenses		3,313			1,161			743			-			5,217
Amortization Expense		-			-			334			-			334
Depreciation expense		-			-			816			-			816
Total other expenses		13,656			792			5,065			-			19,513
Net (loss) income before income tax		(13,656	)		68,690			(3,326	)		(2,136	)		49,572
Income tax		1			-			38			-			39
(Loss) income from continuing operations		(13,657	)		68,690			(3,364	)		(2,136	)		49,533
Net income from discontinued operations (net of tax expense of  $2,284)		-			-			2,243			2,136			4,379
Gain on sale from discontinued operations		-			-			1,774			-			1,774
Impairment charges		-						(2,560	)					(2,560	)
Total income from discontinued operations		-			-			1,457			2,136			3,593
Net (loss) income	$	(13,657	)	$	68,690		$	(1,907	)	$	-		$	53,126
Total assets	$	873		$	926,830		$	93,498		$	(52,789	)	$	968,412
	For the Nine Months Ended September 30, 2011
	Corporate/ Unallocated			Debt Investments			Real Estate Investments			Inter-segment Transactions			Consolidated Total
	(dollars in thousands)
Net interest income:
Interest income	$	-		$	64,672		$	-		$	-		$	64,672
Interest expense		-			(2,295	)		-			-			(2,295	)
Servicing fees		-			(429	)		-			-			(429	)
Net interest income		-			61,948			-			-			61,948
Other income:
Realized gains on sales of investments		-			13,925			-			-			13,925
Miscellaneous fee income		-			217			-			-			217
Total other income		-			14,142			-			-			14,142
Other expenses:
Provision for loan losses, net		-			127			-			-			127
Management fees to affiliate		7,398			-			-			-			7,398
General and administrative		1,846			96			-			-			1,942
Total other expenses		9,244			223			-			-			9,467
Net (loss) income before income tax		(9,244	)		75,867			-			-			66,623
Income tax		1			-			-			-			1
Net (loss) income	$	(9,245	)	$	75,867		$	-		$	-		$	66,622
Total assets	$	788		$	946,207		$	-		$	-		$	946,995

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18. Subsequent Events

The United States Government filed an action in the U.S. District Court Eastern District of New York on April 17, 2012 relating to the collateral securing one of the Company’s loans that is classified as a Watch List loan as of September 30, 2012.  On July 5, 2012, the Company provided a notice to the borrower that an event of default under the loan agreements had occurred as a result of the borrower’s failure to pay interest due and owing and replenish the debt reserve account.  The Company continues to evaluate the loan in connection with the proposed allegations.  The Company has a perfected security interest in the collateral underlying the loan and believes the loan is currently fully collateralized and expects to recover our net investment in the loan, which approximates $13.0 million at September 30, 2012.  The Company does not expect the final resolution of the aforementioned action to have a material impact on the Company’s consolidated financial statements.

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Item 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements

We make forward-looking statements in this report that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words ‘‘believe,’’ ‘‘expect,’’ ‘‘anticipate,’’ ‘‘estimate,’’ ‘‘plan,’’ ‘‘continue,’’ ‘‘intend,’’ ‘‘should,’’ ‘‘may,’’ ‘‘would,’’ “will,” or similar expressions, we intend to identify forward-looking statements.  Statements regarding the following subjects, among others, are forward-looking by their nature:

● our business and strategy;

● our ability to obtain and maintain financing arrangements and the terms of such arrangements;

● financing and advance rates for our targeted assets;

● general volatility of the markets in which we acquire assets;

● the implementation, timing and impact of, and changes to, various government programs;

● our expected assets;

● changes in the value of our assets;

● market trends in our industry, interest rates, the debt securities markets or the general economy;

● rates of default or decreased recovery rates on our assets;

● our continuing or future relationships with third parties;

● prepayments of the mortgage and other loans underlying our mortgage-backed or other asset-backed securities;

● the degree to which our hedging strategies may or may not protect us from interest rate volatility;

● changes in governmental regulations, tax law and rates, accounting guidance, and similar matters;

● our ability to maintain our qualification as a REIT for federal income tax purposes;

● ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended;

● the availability of opportunities in real estate-related and other securities;

● the availability of qualified personnel;

● estimates relating to our ability to make distributions to our stockholders in the future;

● our understanding of our competition;

● interest rate mismatches between our assets and our borrowings used to finance purchases of such assets;

● changes in interest rates and mortgage prepayment rates;

● the effects of interest rate caps on our adjustable-rate mortgage-backed securities;

● our ability to integrate acquired assets into our existing portfolio; and

● our ability to realize our expectations of the advantages of acquiring assets.

The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us.  For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in forward looking statements, see our most recent Annual Report on Form 10-K and any subsequent Quarterly Report on Form 10-Q.  If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements.  Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise from time to time, and it is impossible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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Executive Summary

We are a commercial real estate company that acquires, manages, and finances, directly or through our subsidiaries, commercial mortgage loans and other commercial real estate debt, commercial real property, commercial mortgage-backed securities, or CMBS, other commercial real estate-related assets and Agency residential mortgage-backed securities.  We expect that the commercial real estate loans we acquire will be fixed and floating rate first mortgage loans secured by commercial properties.  We may also acquire subordinated commercial mortgage loans and mezzanine loans.  We have also invested in long-term sale-leaseback and build-to-suit transactions for companies in the U.S. and we may engage in these transactions in Europe.  The long term sale-leaseback and build to suit properties are triple-net leased to corporate tenants.  The triple-net leases require that in sale-leaseback transactions, each tenant pays substantially all of the costs associated with operating and maintaining the property, including real estate taxes, assessments and other government charges, insurance, utilities, repairs and maintenance and capital expenditures.  From time to time, we also acquire commercial real property as part of our resolution of commercial mortgage loans and other commercial real estate debt where a borrower defaults on their obligations and we take title to the collateral underlying the commercial mortgage loans and other commercial real estate debt through foreclosure or other means.

We acquire CMBS which are rated AAA through BBB as well as CMBS that are below investment grade or are non-rated.  The other commercial real estate-related securities and other commercial real estate asset classes consist of debt and equity tranches of commercial real estate collateralized debt obligations, or CRE CDOs, loans to real estate companies including real estate investment trusts, or REITs, and real estate operating companies, or REOCs, commercial real estate securities and commercial real property.  In addition, we may acquire residential mortgage-backed securities, or RMBS, for which a U.S. Government agency such as Ginnie Mae, or a federally chartered corporation such as Fannie Mae and Freddie Mac, guarantees payments of principal and interest on the securities.  We refer to these securities as Agency RMBS.  We refer to Ginnie Mae, Fannie Mae, and Freddie Mac collectively as the Agencies.

We are externally managed by Fixed Income Discount Advisory Company, which we refer to as FIDAC, or our Manager.  FIDAC is a wholly owned subsidiary of Annaly Capital Management, Inc., or Annaly.

We have elected to be taxed as a REIT for federal income tax purposes commencing with our taxable year ending on December 31, 2009.  Our targeted asset classes and the principal investments we expect to make in each include:

● Commercial Mortgage Loans, consisting of:

o        A-Notes and other first mortgage loans that are secured by commercial and multifamily properties

o        Construction loans

● Subordinated Debt and Preferred Equity

o        B-Notes, C-Notes, and other subordinated notes

o        Mezzanine loans

o        Loan participations

o        Preferred equity

● Commercial Real Property

o        Office buildings

o        Hotels

o        Retail

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o        Industrial

o        Multifamily

o        Residential condominiums

o        Other commercial real property including land

● Commercial Mortgage-Backed Securities, or CMBS, consisting of:

o        CMBS rated AAA through BBB

o        CMBS that are rated below investment grade or are non-rated

● Other Commercial Real Estate Assets, consisting of:

o        Debt and equity tranches of CRE CDOs

o        Loans to real estate companies including REITs and REOCs

o        Commercial real estate securities

● Agency RMBS:

o        Single-family residential mortgage pass-through certificates representing interests in “pools” of mortgage loans secured by residential real property where payments of both interest and principal are guaranteed by a U.S. Government agency or federally chartered corporation

Our principal business objective is to capitalize on the fundamental changes that have occurred and are occurring in the commercial real estate finance industry to provide attractive risk adjusted returns to our stockholders over the long term, primarily through dividends and secondarily through capital appreciation.  In order to capitalize on the changing sets of opportunities that may be present in the various points of an economic cycle, we may expand or refocus our strategy by emphasizing assets in different parts of the capital structure and different real estate sectors.  We expect to continue to deploy our capital through the origination and acquisition of commercial first mortgage loans, CMBS, mezzanine financings and other commercial real-estate debt instruments at attractive risk-adjusted yields as well as directly in commercial real property, and CMBS and Agency RMBS.  We expect to allocate our capital within our targeted asset classes opportunistically based upon our Manager’s assessment of the risk-reward profiles of particular assets.  Our strategy may be amended from time to time, if recommended by our Manager and approved by our board of directors.  If we amend our asset strategy, we are not required to seek stockholder approval.

We expect that over the near term our investment portfolio will be weighted toward commercial real estate loans and other commercial real estate debt and commercial real property, subject to maintaining our REIT qualification and our 1940 Act exemption.

We use borrowings as part of our financing strategy.  We have financed our triple-net lease portfolio with non-recourse financings, which generally limit the recoverability of the loan to the property.  These financings may be specific to a particular property or secured by a portfolio of our properties.  We anticipate that the loan to value ratio for these financing will be between 40% and 65% and would likely not exceed 80%.

Although we are not required to maintain any particular leverage ratio, the amount of leverage we incur is determined by our Manager, taking into account a variety of factors, which may include the anticipated liquidity and price volatility of the assets in our portfolio, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing our assets, the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial and residential mortgage markets, the outlook for the level, slope, and volatility of interest rate movement, the credit quality of our target assets and the collateral underlying our target assets.  We may enhance the returns on our commercial mortgage loan assets, especially loan acquisitions, through securitizations.  We may also sell the senior portion or

A-Note and retain the subordinate or junior position in a B-Note or other subordinate loan.  If possible, we may securitize the senior portion, expected to be equivalent to investment grade rated CMBS, while retaining the subordinate securities in our portfolio.  We use repurchase agreements to finance acquisitions of Agency RMBS with a number of counterparties.  We expect to leverage our triple-net lease investments.  In the future, we may also use other sources of financing to fund the acquisition of our targeted assets, including warehouse facilities and other secured and unsecured forms of borrowing.  We may also seek to raise further equity capital or issue debt securities to fund our future asset acquisitions.

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Subject to maintaining our qualification as a REIT, we may, from time to time, utilize derivative financial instruments to mitigate the effects of fluctuations in interest rates and its effects on our asset valuations.  We also may engage in a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.  We may attempt to reduce interest rate risk and to minimize exposure to interest rate fluctuations through the use of match funded financing structures, when appropriate.  We expect these instruments will allow us to minimize, but not eliminate, the risk that we have to refinance our liabilities before the maturities of our assets and to reduce the impact of changing interest rates on our earnings.

Factors Impacting our Operating Results

In addition to the prevailing market conditions, our operations are affected by a number of factors and primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, commercial mortgage loans, commercial real estate debt, CMBS and other financial assets in the marketplace. Our net interest income includes the actual payments we receive and is also impacted by the amortization of purchase premiums and accretion of purchase discounts. Our net interest income varies over time, primarily as a result of changes in interest rates, and with respect to Agency RMBS we own, prepayment rates and prepayment speeds as measured by the Constant Prepayment Rate, or CPR, on our CMBS and Agency RMBS assets. Interest rates and prepayment rates vary according to the type of asset, conditions in the financial markets, credit worthiness of our borrowers, competition and other factors, none of which can be predicted with certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers whose mortgage loans are held directly by us or are included in our CMBS.

Change in Fair Value of our Assets. It is our business strategy to hold our targeted assets as long-term investments. As such, we expect that our CMBS and Agency RMBS will be carried at their fair value, as available-for-sale securities in accordance with ASC 320 Investments in Debt and Equity Securities, with changes in fair value recorded through accumulated other comprehensive income (loss) rather than through earnings. As a result, we do not expect that changes in the fair value of the assets will normally impact our operating results. At least on a quarterly basis, however, we will assess both our ability and intent to continue to hold such assets as long-term investments. As part of this process, we will monitor our targeted assets for other-than-temporary impairment, or OTTI, including OTTI attributable to credit losses. A change in our ability or intent to continue to hold any of our investment securities could result in our recognizing an impairment charge or realizing losses upon the sale of such securities.

Credit Risk. We may be exposed to various levels of credit risk depending on the nature of our investments and the nature and level of the assets underlying the investments and credit enhancements, if any, supporting our assets. FIDAC and FIDAC’s Investment Committee approve and monitor credit risk and other risks associated with each investment.  We review loan to value metrics upon either the origination or the acquisition of a new investment but generally not in the course of quarterly surveillance. We generally review the most recent financial information produced by the borrower, net operating income, or NOI, debt service coverage ratios, or DSCR, property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of our assets, and may consider other factors we deem important. We review market pricing to determine the refinanceability of the asset.  We review economic trends, both macro as well as those directly affecting the property, and the supply and demand of competing projects in the sub-market in which the subject property is located. We also evaluate the borrower’s ability to manage and operate the properties.

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Based upon the review, loans are assigned an internal rating of Performing Loans, Watch List Loans or Workout Loans.   Loans that are deemed Performing Loans meet all present contractual obligations.  Watch List Loans are defined as performing or nonperforming loans for which the timing of cost recovery is under review.  Workout Loans are defined as loans for which there is a likelihood that we may not recover its cost basis.

Size of Portfolio. The size of our portfolio, as measured by the aggregate unpaid principal balance of our mortgage loans and aggregate principal balance of our mortgage related securities and the other assets we own is also a key revenue driver. Generally, as the size of our portfolio grows, the amount of interest income we receive increases. The larger portfolio, however, may drive increased expenses if we incur additional interest expense to finance the purchase of our assets.

Changes in Market Interest Rates. With respect to our business operations, increases in interest rates, in general, may over time cause:

● the interest expense associated with our borrowings to increase;

● the value of our mortgage loans, CMBS and Agency RMBS, to decline;

● coupons on our adjustable rate mortgage loans, CMBS and Agency RMBS to reset, although on a delayed basis, to higher interest rates;

● to the extent applicable under the terms of our investments, prepayments on our mortgage loan portfolio, CMBS and Agency RMBS to slow, thereby slowing the amortization of our purchase premiums and the accretion of our purchase discounts; and

● to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase.

Conversely, decreases in interest rates, in general, may over time cause:

● to the extent applicable under the terms of our investments, prepayments on our mortgage loan, CMBS and Agency RMBS portfolio to increase, thereby accelerating the amortization of our purchase premiums and the accretion of our purchase discounts;

● the interest expense associated with our borrowings to decrease;

● the value of our mortgage loan, CMBS and Agency RMBS portfolio to increase;

● to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease; and

● coupons on our adjustable-rate mortgage loans, CMBS and Agency RMBS to reset, although on a delayed basis, to lower interest rates

Since changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to effectively manage interest rate risks and prepayment risks while maintaining our status as a REIT.

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Investment Activities

At September 30, 2012, our investment portfolio consisted of $731.8 million of loans, $39.8 million of preferred equity and $78.7 million of equity investments in real estate, which includes real estate held for sale.

The following segmented table summarizes certain characteristics of our investment portfolio at September 30, 2012 and December 31, 2011:

	As of September 30, 2012			As of December 31, 2011
Commercial Real Estate Debt and Preferred Equity Portfolio	(dollars in thousands)
Commercial real estate debt and preferred equity investment portfolio at period-end	$	771,584		$	752,801
Fixed-rate investments as percentage of portfolio		65	%		38	%
Adjustable rate investments as percentage of portfolio		35	%		62	%
Fixed-rate investments
Commercial real estate debt as percentage of fixed-rate assets		92	%		100	%
Commercial preferred equity as percentage of fixed-rate assets		8	%		-
Adjustable rate investments
Commercial mortgage loans as percentage of adjustable-rate assets		100	%		100	%
Weighted average yield on interest earning assets at period-end		10.29	%		29.86	%
Real Estate Properties Portfolio including Real Estate Held for Sale
Real estate investment at period-end		78,703			33,196
Financing on real estate		19,150			16,600
Annualized yield on real estate investment portfolio at period end (1)		9.44	%		7.67	%
Weighted average cost of funds on real estate investment financing(2)		3.49	%		3.50	%

(1)	The impairment charge and gain on sales related to discontinued operations were not annualized for purposes of determining the yield on equity.
(2)	Includes the effect of the interest rate swap for the quarter ended September 30, 2012.

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The following table represents our debt portfolio at September 30, 2012:

Commercial Loans on Real Estate
September 30, 2012
(dollars in thousands)
Property Type							Stated	Payment				Carrying
Commercial mortgage loans		Location	Coupon				Maturity Date	Terms		Face Amount		Amount
	Hotel	Grand Cayman		6.75	%		Oct-14		I/O	$	43,400	$	43,400
	Retail	IN		4.75	%		Nov-14		I/O		23,814		23,814
	Retail	CO		5.58	%		May-17	30 year			17,772		15,575
	Condo	NY		-	%	(1)	Dec-13		I/O		12,973		12,973
	Condo	NJ		12.08	%		Dec-14		I/O		2,516		2,513
	Industrial	TX		6.40	%		Aug-14		I/O		34,000		35,662
	Retail	PA		4.50	%		Aug-15		I/O		12,500		12,500
Commercial mortgage loans: weighted average coupon				5.51	%		Commercial mortgage loans total			$	146,975	$	146,437
Subordinate & Mezzanine debt (2)
	Office	Various		11.50	%		Dec-14		I/O	$	96,304	$	96,304
	Retail	Various		11.25	%		Apr-17	25 year			87,412		87,412
	Industrial	Various		11.00	%		Jun-17		I/O		50,000		50,000
	Retail	Various		7.71	%		Dec-15	Fixed paydown			45,925		42,905
	Hotel	TX		10.53	%		Sep-16		I/O		44,000		44,000
	Retail	Various		12.24	%		Dec-19		I/O		40,000		40,000
	Retail	TX		11.25	%		Apr-15	30 year			27,130		27,130
	Office	IL		6.66	%		Jun-15		I/O		25,000		23,107
	Office	GA		12.17	%		Oct-13		I/O		20,500		20,500
	Office	CA		11.13	%		Oct-14		I/O		20,000		20,000
	Office	NY		11.15	%		Sep-21		I/O		18,000		18,000
	Hotel	NY		10.83	%		Sep-13		I/O		17,000		17,000
	Office	IL		5.64	%		Jan-15	30 year			16,495		15,730
	Hotel	NY		12.61	%		Sep-13		I/O		13,000		13,000
	Office	NY		10.00	%		Jul-21		I/O		10,000		10,000
	Hotel	CA		12.25	%		Apr-17		I/O		8,000		8,000
	Office	IL		12.25	%		Aug-15		I/O		6,500		6,500
	Office	NY		10.00	%		Dec-14	Fully Amortizing			4,385		4,385
	Retail	IN		16.79	%		Nov-14		I/O		4,518		4,518
	Office	MD		11.70	%		Aug-17		I/O		9,942		9,942
	Office	MD		11.20	%		Aug-17		I/O		10,130		10,130
	Industrial	TX		6.40	%		Aug-14		I/O		12,500		10,815
	Retail	PA		11.75	%		Aug-15		I/O		6,000		6,000
Subordinate & mezzanine debt: weighted average coupon				10.65	%		Subordinate & mezzanine debt total			$	592,741	$	585,378
	Total debt portfolio: weighted average coupon			9.63	%		Total debt portfolio			$	739,716	$	731,815
Preferred Equity
	Multi-family	MD		11.00	%		Aug-22		I/O	$	39,769	$	39,769
Commercial real estate debt and preferred equity portfolio: weighted average coupon				9.70	%		Total commercial real estate debt and prefered equity portfolio			$	779,485	$	771,584
(1) Loan on non-accrual status as of September 30, 2012.
(2) Subject to prior liens.

Results of Operations

Net Income Summary

Our net income for the quarter and nine months ended September 30, 2012 was $22.6 million and $53.1 million, or $0.30 and $0.69 per average share, respectively.  Our net income for the quarter and nine months ended September 30, 2011 was $39.9 million and $66.6 million, or $0.52 and $1.15 per share, respectively.   We attribute the decrease in net income for the quarter ending September 30, 2012 primarily to the decrease in accretion income of $22.2 million, partially offset by an increase of coupon related interest income of $5.1 million as compared to the quarter ended September 30, 2011.  We primarily attribute the decrease in net income for the nine months ended September 30, 2012 to the  sale of our CMBS portfolio for a gain of $13.9 million during the nine months ended September 30, 2011.

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The table below presents the Consolidated Statements of Comprehensive Income for the quarters and nine months ended September 30, 2012 and 2011:

CREXUS  INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except share and per share data)
	For the Quarter Ended
	September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Net interest income:
Interest income	$	26,841		$	44,174		$	67,745		$	64,672
Interest expense		(187	)		(21	)		(857	)		(2,295	)
Servicing fees		(149	)		(213	)		(378	)		(429	)
Net interest income		26,505			43,940			66,510			61,948
Other income:
Realized loss on sale of loan		-			-			(525	)		-
Realized gains on sales of investments		-			-			-			13,925
Miscellaneous fee income		126			217			768			217
Rental income		809			-			2,332			-
Total other income		935			217			2,575			14,142
Other expenses:
Provision for loan losses, net		-			-			2,803			127
Management fees to affiliate		3,446			3,373			10,343			7,398
General and administrative expenses		1,327			848			5,217			1,942
Amortization expense		105			-			334			-
Depreciation expense		271			-			816			-
Total other expenses		5,149			4,221			19,513			9,467
Income before income tax		22,291			39,936			49,572			66,623
Income tax		6			-			39			1
Net income from continuing operations		22,285			39,936			49,533			66,622
Net income from discontinued operations (net of tax expense    of $425, $0, $2,284 and $0, respectively)		2,903			-			4,379			-
Gain on sale from discontinued operations		-			-			1,774			-
Impairment charges		(2,560	)		-			(2,560	)		-
Total income from discontinued operations		343			-			3,593			-
Net Income	$	22,628		$	39,936		$	53,126		$	66,622
Net income per average share-basic and diluted, continuing operations	$	0.29		$	0.52		$	0.65		$	1.15
Total income per average share-basic and diluted, discontinued operations		0.01			-			0.04			-
Net income per average share-basic and diluted	$	0.30		$	0.52		$	0.69		$	1.15
Dividend declared per share of common stock	$	0.32		$	0.30		$	0.86		$	0.78
Weighted average number of shares outstanding-basic and diluted		76,630,528			76,620,112			76,625,054			57,887,511
Comprehensive income:
Net income	$	22,628		$	39,936		$	53,126		$	66,622
Other comprehensive income:
Unrealized gains on securities available-for-sale		-			1,649			-			7,847
Reclassification adjustment for realized gains included in net income		-			-			-			(13,925	)
Total other comprehensive income		-			1,649			-			(6,078	)
Comprehensive income	$	22,628		$	41,585		$	53,126		$	60,544

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Interest Income and Average Earning Asset Yield

We had average earning assets of $747.0 million and $1.1 billion for the quarters ended September 30, 2012 and 2011, respectively, decreasing primarily as a result of the sale of Agency RMBS during the quarter ended December 31, 2011.  Our interest income, net of service fees, was $26.7 million and $44.0 million for the quarters ended September 30, 2012 and 2011, respectively and the yield on our portfolio, excluding cash, was 14.29% and 16.42% for the quarters ended September 30, 2012 and 2011, respectively.  Interest income decreased $17.3 million due to a net decrease in accretion income of $22.2 million, partially offset by an increase of coupon related interest income of $5.1 million as compared to the quarter ended September 30, 2011.

We had average earning assets of $691.8 million and $868.7 million for the nine months ended September 30, 2012 and 2011, respectively, decreasing primarily as a result of the sale of Agency RMBS during the quarter ended December 31, 2011.  Our interest income, net of service fees, was $67.4 million and $64.2 million for the nine months ended September 30, 2012 and 2011, respectively and the yield on our portfolio, excluding cash, was 12.98% and 9.89% for the nine months ended September 30, 2012 and 2011, respectively.  Interest income, net of service fees, increased $3.2 million primarily due to an overall increase in the weighted average coupon of the portfolio.

Interest Expense and the Cost of Funds

We had average borrowed funds of $19.2 million and $40.0 million and total interest expense, which includes the change in market value of the swap, of $187 thousand and $21 thousand for the quarters ended September 30, 2012 and 2011, respectively and our average cost of funds, including the change in market value of the interest rate swap, was 3.92% and 0.21% for the quarters ended September 30, 2012 and 2011, respectively.  Our interest expense increased $166 thousand for the quarter ended September 30, 2012 as compared to the quarter ended September 30, 2011 primarily due to a higher weighted average cost of funds.

We had average borrowed funds of $26.1 million and $110.0 million and total interest expense, which includes the change in market value of the interest rate swap, of $857 thousand and $2.3 million for the nine months ended September 30, 2012 and 2011, respectively, and our average cost of funds, including the change in market value of the interest rate swap, was 4.39% and 2.78% for the nine months ended September 30, 2012 and 2011, respectively.  Our interest expense decreased $1.4 million for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 primarily due to the repayment of the TALF debt.

Net Interest Income

Our net interest income, which equals interest income less interest expense and service fees, totaled $26.5 million and $43.9 million for the quarters ended September 30, 2012 and 2011, respectively.  Our net interest income decreased $17.4 million primarily due to a net of a decrease in accretion income of $22.2 million, offset by an increase of coupon related interest income of $5.1 million as compared to  the quarter ended September 30, 2011.  Our net interest spread, which equals the yield on our average assets for the period less the average cost of funds for the period, was 10.37% and 16.21% for the quarters September 30, 2012 and 2011, respectively.  For the quarter ended September 30, 2012, the decrease in net interest spread is primarily due to a decrease in the recognition of accretion income when compared to the quarter ended September 30, 2011.

Our net interest income totaled $66.5 million and $61.9 million for the nine months ended September 30, 2012 and 2011, respectively.  Our net interest income increased $4.6 million primarily due to the purchase of additional assets and an increase in the portfolio’s weighted average coupon for the quarter ended September 30, 2012 when compared to the quarter ended September 30, 2011.  Our net interest spread was 8.59% and 7.11% for the nine months ended September 30, 2012 and 2011, respectively.  For the nine months ended September 30, 2012, the increase in net interest spread is primarily due to an increase in the weighted average coupon of the portfolio compared to the nine months ended September 30, 2011.

The table below summarizes our average earning assets held, total interest income, weighted average yield on average interest earning assets for the period, average balance of interest bearing liabilities, interest expense, weighted average cost of funds for the period, net interest income, and net interest rate spread for the periods presented.

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Net Interest Income
(Ratios have been annualized, dollars in thousands)
					Yield on
	Average				Average			Average									Net
	Earning		Interest		Interest			Interest				Average			Net		Interest
	Assets		Earned on		Earning			Bearing		Interest		Cost			Interest		Rate
	Held (1)		Assets (2)		Assets (1)(2)			Liabilities		Expense		of Funds			Income		Spread
For the quarter ended September 30, 2012	$	747,049	$	26,692		14.29	%	$	19,150	$	187		3.92	%	$	26,505		10.37	%
For the quarter ended June 30, 2012	$	638,619	$	17,564		11.00	%	$	27,392	$	310		3.49	%	$	17,254		7.51	%
For the quarter ended March 31, 2012	$	689,210	$	23,105		13.41	%	$	31,656	$	360		4.55	%	$	22,745		8.86	%
For the year ended December 31, 2011	$	866,731	$	105,658		12.19	%	$	82,836	$	2,370		2.86	%	$	103,288		9.33	%
For the quarter ended December 31, 2011	$	860,842	$	41,426		19.25	%	$	2,113	$	75		14.19	%	$	41,351		5.06	%
For the quarter ended September 30, 2011	$	1,070,659	$	43,961		16.42	%	$	40,000	$	21		0.21	%	$	43,940		16.21	%
For the quarter ended June 30, 2011	$	1,112,767	$	12,898		4.64	%	$	118,965	$	742		2.49	%	$	12,156		2.15	%
For the quarter ended March 31, 2011	$	415,519	$	7,380		7.10	%	$	172,612	$	1,532		3.60	%	$	5,848		3.50	%
(1) Excludes cash and cash equivalents.
(2) Net of servicing fees.

Rental Income

Our rental income for the quarter and nine months ended September 30, 2012 was $809 thousand and $2.3 million, respectively, which is directly attributable to our investments in real estate.  We had no rental income for the quarter and nine months ended September 30, 2011.

Management Fee and General and Administrative Expenses

We paid FIDAC management fees of $3.4 million for each of the quarters ended September 30, 2012 and 2011.  We paid FIDAC management fees of $10.3 million and $7.4 million for the nine months ended September 30, 2012 and 2011, respectively.  The increase is due primarily to the increase in stockholders’ equity for the comparable period.

General and administrative expenses, or G&A expenses, were $1.3 million and $0.8 million for the quarters ended September 30, 2012 and 2011, respectively.   The increase is primarily attributable to an increase in costs associated with an increase in the overall number of commercial mortgage debt instruments and real estate properties in our portfolio for the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011.  G&A expenses were $5.2 million and $1.9 million for the nine months ended September 30, 2012 and 2011, respectively.   The increase is primarily attributable to costs associated with taking possession of collateral underlying loans via a deed in lieu of foreclosure during the nine months ended September 30, 2012.

Total expenses as a percentage of average total assets, excluding provision for loan losses, depreciation and amortization, were 1.97% and 1.76% for the quarters ended September 30, 2012 and 2011, respectively.  The increase is attributable to an increase in license fees, legal and accounting fees.

Currently, FIDAC has waived its right to require us to pay our pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of FIDAC and its affiliates required for our operations.

The table below shows our total management fee and G&A expenses as a percentage of average total assets and average equity for the periods presented.

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Management Fees, G&A Expenses and Operating Expense Ratios
(Ratios have been annualized, dollars in thousands)
	Total Management		Total Management			Total Management
	Fee and G&A		Fee and G&A			Fee and G&A
	Expenses		Expenses/Average			Expenses/Average
			Total Assets			Equity
For the quarter ended September 30, 2012	$	4,773		1.97	%		2.07	%
For the quarter ended June 30, 2012	$	4,606		1.88	%		2.00	%
For the quarter ended March 31, 2012	$	6,181		2.50	%		2.67	%
For the year ended December 31, 2011	$	14,169		1.36	%		1.57	%
For the quarter ended December 31, 2011	$	4,829		1.99	%		2.10	%
For the quarter ended September 30, 2011	$	4,221		1.76	%		1.86	%
For the quarter ended June 30, 2011	$	3,959		1.42	%		1.80	%
For the quarter ended March 31, 2011	$	1,160		0.54	%		1.73	%

Net Income and Return on Average Equity

Our net income was $22.6 million for the quarter ended September 30, 2012 as compared to $39.9 million for the quarter ended September 30, 2011.  The decrease is primarily due to the recognition of additional accretion income during the quarter ended September 30, 2011.  Our net income was $53.1 million for the nine months ended September 30, 2012 as compared to $66.6 million for the nine months ended September 30, 2011.  The decrease in net income is primarily due to the gain on sale of our CMBS portfolio of $13.9 million during the quarter ended September 30, 2011.  The table below summarizes our net interest income, fee income, rental income, total expenses, realized gains (losses), income (loss) from discontinued operations and gain on sale from discontinued operations each as a percentage of average equity, and the return on average equity for the periods presented.

Components of Return on Average Equity
(Ratios have been annualized)
	Net Interest			Fee			Rental			Total			Realized			Discontinued			Return
	Income/			Income/			Income/			Expenses(1)/			Gains (Losses)/			Operations/(2)			on
	Average			Average			Average			Average			Average			Average			Average
	Equity			Equity			Equity			Equity			Equity			Equity			Equity
For the quarter ended September 30, 2012		11.52	%		0.05	%		0.35	%		(2.24	%)		0.00	%		0.15	%		9.83	%
For the quarter ended June 30, 2012		7.49	%		0.06	%		0.35	%		(2.18	%)		(0.23	%)		(0.02	%)		6.24	%
For the quarter ended March 31, 2012		9.84	%		0.22	%		0.31	%		(4.06	%)		0.00	%		0.66	%		6.97	%
For the year ended December 31, 2011		11.45	%		0.08	%		0.03	%		(1.57	%)		2.05	%		0.00	%		12.04	%
For the quarter ended December 31, 2011		17.94	%		0.22	%		0.10	%		(2.10	%)		1.98	%		0.00	%		18.14	%
For the quarter ended September 30, 2011		19.37	%		0.10	%		0.00	%		(1.86	%)		0.00	%		0.00	%		17.61	%
For the quarter ended June 30, 2011		5.51	%		0.00	%		0.00	%		(1.80	%)		6.32	%		0.00	%		10.03	%
For the quarter ended March 31, 2011		8.71	%		0.00	%		0.00	%		(1.91	%)		0.00	%		0.00	%		6.80	%
(1) Includes provision for loan loss, depreciation and amortization.
(2) Includes net income, gain on sale and impairment charges related to discontinued operations.

Discontinued Operations

We recorded net income of approximately $2.9 million and $4.4 million from discontinued operations during the quarter and nine months ended September 30, 2012, respectively, which represents the net operating results of the hotels acquired during the quarter ended March 31, 2012 via deed in lieu of foreclosure.  Net income from discontinued operations is recorded net of tax expense of $425 thousand and $2.3 million for the quarter and nine months ended September 30, 2012, respectively.  We recorded a pre-tax gain on sale from discontinued operations of $1.8 million during the nine months ended September 30, 2012.  Additionally, we incurred a $2.6 million and $0 impairment charge on real estate held for sale for the quarters and nine months ended September 30, 2012 and 2011, respectively.  We had no activities classified as discontinued operations for the quarter and nine months ended September 30, 2011.

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Liquidity and Capital Resources

Liquidity measures our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs.  We will primarily use cash to purchase our targeted assets, repay principal and interest on our borrowings, make distributions to our stockholders and fund our operations.  Our primary sources of cash will generally consist of the net proceeds from equity offerings, payments of principal, interest and rental income we receive on our portfolio of assets, proceeds from the sale of real estate held for sale and cash generated from operating real estate held for sale.

We have financed our triple-net lease portfolio with non-recourse financings, which generally limit the recoverability of the loan by the creditor to the property.  These financings are generally specific to a particular property or secured by a portfolio of our properties.  We anticipate that the loan to value ratio for these financing will be between 40% and 65% and would likely not exceed 80%. We may utilize structural leverage through securitizations of commercial real estate loans or CMBS. We may also seek to finance the acquisition of Agency RMBS using repurchase agreements with counterparties, which are recourse to us.  With regard to securitizations or selling the senior portion of the loan, the leverage will depend on the market conditions for structuring such transactions.  We anticipate that leverage for Agency RMBS would be available to us, which would provide for a debt-to-equity ratio in the range of 2:1 to 4:1 and would likely not exceed 8:1.  Based on current market conditions, we expect to operate within the leverage levels described above in the near and long-term.  We can provide no assurance that we will be able to obtain financing on favorable terms, or at all.

Securitizations

We may seek to enhance the returns on our commercial mortgage loan investments, especially loan acquisitions, through securitization. If available, we may securitize the senior portion, expected to be equivalent to AAA-rated CMBS, while retaining the subordinate securities in our portfolio.

Other Sources of Financing

We have used and may continue to use repurchase agreements to finance acquisitions of Agency RMBS with a number of counterparties. Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties (i.e., lenders) in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (a margin call), which may take the form of additional securities or cash.  Similarly, if the estimated fair value of interest earning assets increases due to changes in market interest rates or market factors, lenders may release collateral back to us.  Specifically, margin calls result from a decline in the value of our Agency RMBS securing our repurchase agreements, prepayments on the mortgages securing such Agency RMBS and changes in the estimated fair value of such Agency RMBS generally due to principal reduction of such Agency RMBS from scheduled amortization and resulting from changes in market interest rates and other market factors.  Our repurchase agreements generally provide that the valuations for the Agency RMBS securing our repurchase agreements are to be obtained from a generally recognized source agreed to by the parties.  However, in certain circumstances and under certain of our repurchase agreements our lenders have the sole discretion to determine the value of the Agency RMBS securing our repurchase agreements.  In instances where we have agreed to permit our lenders to make a determination of the value of the Agency RMBS securing our repurchase agreements, such lenders are required to act in good faith in making such valuation determinations and in certain of these instances are also required to act reasonably in this determination.  Our repurchase agreements generally provide that in the event of a margin call we must provide additional securities or cash on the same business day that a margin call is made, if the lender provides us notice prior to the margin notice deadline on such day.  As of September 30, 2012, we did not own any Agency RMBS and consequently have no Agency RMBS pledged or subject to any margin calls under repurchase agreements.  However, should we acquire any Agency RMBS under repurchase agreements, margin calls on the repurchase agreements could result, causing an adverse change in our liquidity position.

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In the future, we may also use other sources of financing to fund the acquisition of our targeted assets, including warehouse facilities and other secured and unsecured forms of borrowing. Our sources of liquidity include selling the senior portion or A-Note and retaining the subordinate or junior position in a B-Note or other subordinate loan.  We may also seek to raise further equity capital or issue debt securities in order to fund our future asset acquisitions.

For our short-term (one year or less) and long-term liquidity, which include investing and compliance with collateralization requirements under our repurchase agreements (if the pledged collateral decreases in value or in the event of margin calls created by prepayments of the pledged collateral), we also rely on the cash flow from investments, primarily monthly principal and interest payments to be received on our CMBS and mortgage loans, cash flow from the sale of securities as well as any primary securities offerings authorized by our board of directors.

Based on our current portfolio, leverage ratio and available borrowing arrangements, we believe our assets will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as to fund our investment activities, pay fees under our management agreement, fund our distributions to stockholders and pay general corporate expenses. However, a decline in the value of our collateral or an increase in prepayment rates substantially above our expectations could cause a temporary liquidity shortfall due to the timing of the necessary margin calls on the financing arrangements and the actual receipt of the cash related to principal pay-downs. If our cash resources are at any time insufficient to satisfy our liquidity requirements, we may have to sell debt or additional equity securities in a common stock offering. If required, the sale of assets at prices lower than their carrying value would result in losses and reduced income.

Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing and equity capital. Subject to our maintaining our qualification as a REIT, we expect to use a number of sources to finance our investments, including repurchase agreements, warehouse facilities, securitization, commercial paper and term financing CDOs. Such financing will depend on market conditions for capital raises and for the investment of any proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations. Upon liquidation, holders of our debt securities and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock.

We held cash and cash equivalents of approximately $105.6 million and $202.8 million at September 30, 2012 and December 31 2011, respectively.  The net decrease is primarily due to the acquisition of loans, real estate and preferred equity investments and payment of dividends.

Our operating activities provided net cash of approximately $26.2 million, and $10.0 million for the quarters ended September 30, 2012 and 2011, respectively, primarily due to net interest income.  Our operating activities provided net cash of approximately $33.2 million, and $24.8 million for the nine months ended September 30, 2012 and 2011, respectively, primarily due to net interest income.

Our investing activities resulted in the net use of cash of $87.1 million and provided net cash of $65.8 million for the quarters ended September 30, 2012 and 2011, respectively, primarily from the purchase of loans and the repayment and pay down of loans and securities, respectively.  Our investing activities resulted in the net use of  cash of $48.0 million and $442.8 million for the nine months ended September 30, 2012 and 2011, respectively.  The net use of cash is primarily due to the purchase of loans and preferred equity for the nine months ended September 30, 2012 and 2011.

Our financing activities for the quarter and nine months ended September 30, 2012 resulted in the net use of cash of $22.7 million and $82.4 million, primarily attributable to $20.7 million and $68.2 million paid in dividends to our common shareholders, respectively. Our financing activities for the quarter and nine months ended September 30, 2011 resulted in the net use of cash of $65.7 million and net proceeds of $434.2 million, respectively.  The use of proceeds during the quarter ended September 30, 2011 is primarily due to the repayment of repurchase agreements of $46.6 million.  The net proceeds from financing activities for the nine months ended September 30, 2011 is primarily attributable to $634.3 million of proceeds from our secondary offering that settled in April 2011, offset by $172.8 million for the repayment of our TALF financing.

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At September 30, 2012, we had outstanding financing agreements of $19.2 million and no repurchase agreements.  At September 30, 2011, we had no outstanding financing arrangements.

We are not required to maintain any specific debt-to-equity ratio as we believe the appropriate leverage for the particular assets we are financing depends on the credit quality and risk of those assets. At September 30, 2012 our total non-recourse debt was approximately $19.2 million which represented a debt-to-equity ratio of approximately 0.02:1.  At December 31, 2011 our total debt was approximately $16.6 million which represented a debt-to-equity ratio of approximately 0.02:1.

Stockholders' Equity

Our charter provides that we may issue up to 1,100,000,000 shares of stock, consisting of up to 1,000,000,000 shares of common stock having a par value of $0.01 per share and up to 100,000,000 shares of preferred stock having a par value of $0.01 per share.

There was no preferred stock issued or outstanding as of September 30, 2012 or December 31, 2011.

Related Party Transactions

Management Agreement

We have entered into a management agreement with FIDAC, pursuant to which FIDAC is entitled to receive a management fee and, in certain circumstances, a termination fee and reimbursement of certain expenses as described in the management agreement.  Such fees and expenses do not have fixed payments.  The management fee is payable quarterly in arrears, and currently is 1.50% per annum, of our stockholders’ equity (as defined in the management agreement).  FIDAC uses the proceeds from its management fee in part to pay compensation to its officers and employees who, notwithstanding that certain of them also are our officers, receive no cash compensation directly from us.

Upon termination without cause, we will pay FIDAC a termination fee.  We may also terminate the management agreement with 30-days’ prior notice from our board of directors, without payment of a termination fee, for cause or upon a change of control of Annaly or FIDAC, each as defined in the management agreement.  FIDAC may terminate the management agreement if we or any of our subsidiaries become required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case we would not be required to pay a termination fee.  FIDAC may also decline to renew the management agreement by providing us with 180-days’ written notice, in which case we would not be required to pay a termination fee.

We are obligated to reimburse FIDAC for its costs incurred under the management agreement.  In addition, the management agreement permits FIDAC to require us to pay for our pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of FIDAC incurred in our operation.  These expenses are allocated between FIDAC and us based on the ratio of our proportion of gross assets compared to all remaining gross assets managed by FIDAC as calculated at each quarter end.  We and FIDAC will modify this allocation methodology, subject to our board of directors’ approval if the allocation becomes inequitable (i.e., if we become very highly leveraged compared to FIDAC’s other funds and accounts).  FIDAC has waived its right to request reimbursement from us of these expenses until such time as it determines to rescind that waiver. 

Purchases of Common Stock by Affiliates

As of September 30, 2012, Annaly owned approximately 12.4% of our outstanding shares of common stock.

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Clearing and Underwriting Fees

We use RCap to clear trades for us and RCap receives customary market-based fees and charges in connection with the provision of such services.  For the quarter ended September 30, 2012 we paid RCap approximately $9 thousand for its services.

Contractual Obligations and Commitments

As of September 30, 2012 we financed a portion of our real estate assets with non-recourse mortgage loans.  The table below provides a summary of our contractual obligations at September 30, 2012 and December 31, 2011.

	September 30, 2012
	Within One Year		One to Three Years		Three to Five Years		Greater Than Five Years		Total
Contractual Obligations	(dollars in thousands)
Loan	$	-	$	313	$	18,837	$	-	$	19,150
Interest expense on loan		670		1,336		881		-		2,887
Total	$	670	$	1,649	$	19,718	$	-	$	22,037
	December 31, 2011
	Within One Year		One to Three Years		Three to Five Years		Greater Than Five Years		Total
Contractual Obligations	(dollars in thousands)
Loan	$	-	$	-	$	16,600	$	-	$	16,600
Interest expense on loan		533		1,162		1,143		-		2,838
Total	$	533	$	1,162	$	17,743	$	-	$	19,438

We agreed to pay the underwriters of our initial public offering $0.15 per share for each share sold in the initial public offering if during any full four calendar quarter period during the 24 full calendar quarters after our initial public offering our Core Earnings (as described below) for any such four-quarter period exceeds an 8% performance hurdle rate (as described below).  The performance hurdle rate will be met if during any full four calendar quarter period during the 24 full calendar quarters after the consummation of our initial public offering our Core Earnings for any such four-quarter period exceeds the product of (x) the weighted average of the issue price per share of all public offerings of our common stock, multiplied by the weighted average number of shares outstanding (including any restricted stock units, any restricted shares of common stock and any other shares of common stock underlying awards granted under our equity incentive plans) in such four-quarter period and (y) 8%.  Core Earnings is a non-GAAP measure and is defined as GAAP net income (loss) excluding non-cash equity compensation expense, depreciation and amortization (to the extent that we foreclose on any properties underlying our target assets), any unrealized gains, losses or other non-cash items recorded for the period, regardless of whether such items are included in other comprehensive income (loss), or in net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between FIDAC and our independent directors and after approval by a majority of our independent directors.  During the quarter ended September 30, 2012 we paid the underwriters $2.0 million, representing the full amount due, as a result of meeting the required hurdle.

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities.

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Dividends

To qualify as a REIT, we must pay annual dividends to our stockholders of at least 90% of our taxable income. We intend to pay regular quarterly dividends to our stockholders. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, which would only be paid out of available cash to the extent permitted under our repurchase facilities, we must first meet both our operating requirements and scheduled debt service on our other debt payable.

During the quarter ended September 30, 2012, we declared dividends to common shareholders totaling $24.5 million or $0.32 per share, which were paid on October 25, 2012.

Capital Expenditures

At September 30, 2012, we had no material commitments for capital expenditures.

Inflation

Virtually all of our assets and liabilities will be interest rate sensitive in nature. As a result, interest rates and other factors will influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our consolidated financial statements are prepared in accordance with GAAP and our distributions will be determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.

Other Matters

We calculate that at least 75% of our assets were qualified REIT assets, as defined in the Code, as of September 30, 2012 and December 31, 2011.   We also calculate that our revenue qualifies for the 75% source of income test and for the 95% source of income test rules for the quarter ended September 30, 2012 and the year ended December 31, 2011 and for each quarter therein.  Consequently, we met the REIT income and asset tests. We also met all REIT requirements regarding the ownership of our common stock and the distribution of our net income.  Therefore, as of September 30, 2012 and December 31, 2011, we believe that we qualified as a REIT under the Code.

We, at all times, intend to conduct our business so as not to become regulated as an investment company under the Investment Company Act of 1940, or the 1940 Act.  If we were to become regulated as an investment company, then our ability to use leverage would be substantially reduced.

Certain of our subsidiaries, including CreXus S Holdings LLC and certain subsidiaries that we may form in the future, rely on the exemption from registration provided by Section 3(c)(5)(C) of the 1940 Act.  Section 3(c)(5)(C) as interpreted by the staff of the Securities and Exchange Commission (or the SEC), requires us to invest at least 55% of our assets in “mortgages and other liens on and interest in real estate” (or Qualifying Real Estate Assets) and at least 80% of our assets in Qualifying Real Estate Assets plus real estate related assets.  The assets that we acquire, therefore, are limited by the provisions of the Investment Company Act and the rules and regulations promulgated under the 1940 Act.

On August 31, 2011, the SEC issued a concept release titled “Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related Instruments” (SEC Release No. IC-29778).  Under the concept release, the SEC is reviewing interpretive issues related to the Section 3(c)(5)(C) exemption.  If the SEC determines that any of the securities we currently treat as Qualifying Real Estate Assets are not Qualifying Real Estate Assets or otherwise believes we do not satisfy the exemption under Section 3(c)(5)(C), we could be required to restructure our activities or sell certain of our assets.  We may be required at times to adopt less efficient methods of financing certain of our mortgage assets and we may be precluded from acquiring certain types of higher yielding mortgage assets.  The net effect of these factors will be to lower our net interest income.  If we fail to qualify for exemption from registration as an investment company, our ability to use leverage would be substantially reduced, and we would not be able to conduct our business as described.   The potential outcomes of the SEC’s actions are unclear as is the SEC’s timetable for its review and actions.

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We determined that as of September 30, 2012 and December 31, 2011, we were in compliance with the exemption from registration provided by Section 3(c)(5)(C) of the Investment Company Act as interpreted by the staff of the SEC.

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary components of our market risk are related to credit risk, interest rate risk, prepayment and market value risk. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

Credit Risk

We are subject to credit risk, which is the risk of loss due to a borrower’s failure to repay principal or interest on a loan, a security or otherwise fail to meet a contractual obligation, in connection with our assets and will face more credit risk on assets we own which are rated below “AAA”. The credit risk related to these assets pertains to the ability and willingness of the borrowers to pay, which is assessed before credit is granted or renewed and periodically reviewed throughout the loan or security term. We believe that residual loan credit quality is primarily determined by the borrowers’ credit profiles and loan characteristics.

FIDAC uses a comprehensive credit review process. FIDAC’s analysis of loans includes borrower profiles, as well as valuation and appraisal data.  FIDAC’s resources include a proprietary portfolio management system, as well as third party software systems.  FIDAC selects loans for review predicated on risk-based criteria such as loan-to-value, a property’s operating history and loan size. FIDAC rejects loans that fail to conform to our standards. FIDAC accepts only those loans which meet our underwriting criteria. Once we own a loan, FIDAC’s surveillance process includes ongoing analysis and oversight by our third-party servicer and us. Additionally, CMBS, other commercial real estate-related securities and Agency RMBS which we acquire for our portfolio will be reviewed by FIDAC to ensure that the assets we acquire satisfy our risk based criteria. FIDAC’s review of CMBS, other commercial real estate-related securities and Agency RMBS includes utilizing its proprietary portfolio management system. FIDAC’s review of CMBS, other commercial real estate-related securities and Agency RMBS is based on quantitative and qualitative analysis of the risk-adjusted returns such securities present.

Loans are assigned an internal rating of “Performing Loans,” “Watch List Loans” or “Workout Loans.”  Performing Loans meet all present contractual obligations.  Watch List Loans are defined as performing or nonperforming loans for which the timing of cost recovery is under review.  Workout Loans are defined as loans for which there is a likelihood that the we may not recover our cost basis.  The criteria used to asses these internal ratings are net operating income (NOI), debt service coverage (DSCR), property debt yields (net cash flow or NOI divided by the amount of outstanding indebtedness), loan per unit and rent rolls relating to each of its assets, and may consider other factors it deems important.  We review market pricing to determine the ability to refinance the asset.  We review economic trends, both macro as well as those directly affecting the property, and the supply and demand of competing projects in the sub-market in which the subject property is located. We also evaluate the borrower’s ability to manage and operate the properties.

Interest Rate Risk

Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors. We are subject to interest rate risk in connection with our assets and any related financing obligations. In general, we may finance the acquisition of our targeted assets through financings in the form of borrowings under programs established by the U.S. government, warehouse facilities, bank credit facilities (including term loans and revolving facilities), resecuritizations, securitizations and repurchase agreements. We may mitigate interest rate risk through utilization of hedging instruments, primarily interest rate swap agreements. Interest rate swap agreements are intended to serve as a hedge against future interest rate increases on our borrowings. Another component of interest rate risk is the effect changes in interest rates will have on the market value of the assets we acquire. We face the risk that the market value of our assets will increase or decrease at different rates than that of our liabilities, including our hedging instruments. We may acquire floating rate mortgage assets. These are assets in which the mortgages are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the asset’s interest yield may change during any given period. Our borrowing costs pursuant to our financing agreements, however, will not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation by caps, while the interest-rate yields on our floating rate mortgage assets would effectively be limited. In addition, floating rate mortgage assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in our receipt of less cash income on such assets than we would need to pay the interest cost on our related borrowings. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would negatively affect our financial condition, cash flows and results of operations.

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Our analysis of interest rate risk is based on FIDAC’s experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of asset allocation decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in this Form 10-Q.

Interest Rate Effect on Net Interest Income

Our operating results depend, in part, on differences between the income from our investments and our borrowing costs. Most of our repurchase agreements would provide financing based on a floating rate of interest calculated on a fixed spread over LIBOR.  The fixed spread varies depending on the type of underlying asset which collateralizes the financing. Accordingly, if a portion of our portfolio consisted of floating interest rate assets that would be match-funded utilizing our expected sources of short-term financing, while our fixed interest rate assets will not be match-funded. During periods of rising interest rates, the borrowing costs associated with our investments could tend to increase while the income earned on our fixed interest rate investments may remain substantially unchanged.  This will result in a narrowing of the net interest spread between the related assets and borrowings and may even result in losses. Further, during this portion of the interest rate and credit cycles, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results. Such delinquencies or defaults could also have an adverse effect on the spread between interest-earning assets and interest-bearing liabilities. Hedging techniques are partly based on assumed levels of prepayments of fixed-rate and hybrid adjustable-rate debt investments. If prepayments are slower or faster than assumed, the life of the debt investments will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns.

Interest Rate Effects on Fair Value

Another component of interest rate risk is the effect changes in interest rates have on the fair value of the assets we acquire. We face the risk that the fair value of our assets will increase or decrease at different rates than that of our liabilities, including our hedging instruments. We primarily assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. Duration is a measure of time.  Duration essentially measures the market price volatility of financial instruments as interest rates change. We generally calculate duration using various financial models and empirical data. Different models and methodologies can produce different durations for the same securities.

It is important to note that the impact of changing interest rates on fair value can change significantly when interest rates change beyond 100 basis points from current levels. Therefore, the volatility in the fair value of our assets could increase significantly when interest rates change beyond 100 basis points. In addition, other factors impact the fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, in the event of changes in actual interest rates, the change in the fair value of our assets would likely differ from that shown below and such difference might be material and adverse to our stockholders.

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Interest Rate Cap Risk

We may invest in adjustable-rate mortgage loans and CMBS. These are mortgages or CMBS in which the underlying mortgages are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the security's interest yield may change during any given period. However, our borrowing costs pursuant to our financing agreements will not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation by caps, while the interest-rate yields on our adjustable-rate mortgage loans and CMBS would effectively be limited. This problem will be magnified to the extent we acquire adjustable-rate CMBS that are not based on mortgages which are fully indexed. In addition, the mortgages or the underlying mortgages in a CMBS may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in our receipt of less cash income on our adjustable-rate mortgages or CMBS than we need in order to pay the interest cost on our related borrowings. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations.

Interest Rate Mismatch Risk

We may fund a portion of our acquisitions of hybrid adjustable-rate mortgages, CMBS and Agency RMBS with borrowings that, after the effect of hedging, have interest rates based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of the mortgages, CMBS and Agency RMBS. Thus, we anticipate that in most cases the interest rate indices and repricing terms of our mortgage assets and our funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. Therefore, our cost of funds would likely rise or fall more quickly than would our earnings rate on assets. During periods of changing interest rates, such interest rate mismatches could negatively impact our financial condition, cash flows and results of operations. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above. Our analysis of risks is based on FIDAC's experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in this Form 10-Q.

Our profitability and the value of our portfolio (including interest rate swaps) may be adversely affected during any period as a result of changing interest rates. The following table quantifies the potential changes in net interest income, and portfolio value should interest rates go up or down 25, 50, and 75 basis points, assuming the yield curves of the rate shocks will be parallel to each other and the current yield curve. All changes in income and value are measured as percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The base interest rate scenario assumes interest rates at September 30, 2012 and various estimates regarding prepayment and all activities are made at each level of rate shock. Actual results could differ significantly from these estimates.

	Projected Percentage Change in				Projected Percentage Change in
Change in Interest Rate	Net Interest Income				Portfolio Fair Value
-75 Basis Points		0.00	%	(1)		2.03	%
-50 Basis Points		0.00	%	(1)		1.36	%
-25 Basis Points		0.00	%			0.68	%
Base Interest Rate		-				-
+25 Basis Points		0.00	%	(1)		(0.68	%)
+50 Basis Points		0.13	%			(1.35	%)
+75 Basis Points		0.61	%			(2.03	%)
(1) Reflects considerations of floors on variable rate loans.

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Prepayment Risk

As we receive prepayments of principal on our assets, premiums paid on such assets will be amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the assets. Conversely, discounts on such investments are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on our assets. For commercial real estate loans, the risk of prepayment is mitigated by call protection, which includes defeasance, yield maintenance premiums and prepayment charges.

Extension Risk

FIDAC computes the projected weighted-average life of our assets based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when a fixed-rate or hybrid adjustable-rate asset is acquired with borrowings, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related assets. This strategy is designed to protect us from rising interest rates because the borrowing costs are fixed for the duration of the fixed-rate portion of the related mortgage-backed security.

If prepayment rates decrease in a rising interest rate environment, however, the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the end of the hedging instrument while the income earned on the hybrid adjustable-rate assets would remain fixed. This situation may also cause the market value of our hybrid adjustable-rate assets to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.

Market Risk

Market Value Risk

Our available-for-sale securities are reflected at their estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss). The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase. As market volatility increases or liquidity decreases, the fair value of our assets may be adversely impacted.

Real Estate Risk

Commercial property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.

Risk Management

To the extent consistent with maintaining our REIT status, we will seek to manage risk exposure to protect our portfolio of commercial mortgage loans, CMBS, commercial real estate related securities, Agency RMBS and related debt against the credit and interest rate risks. We generally seek to manage our risk by:

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● analyzing the borrower profiles, as well as valuation and appraisal data, of the loans we acquire.  FIDAC’s resources include a proprietary portfolio management system, as well as third party software systems;

● using FIDAC’s proprietary portfolio management system to review our CMBS, Agency RMBS and other commercial real estate-related securities;

● monitoring and adjusting, if necessary, the reset index and interest rate related to our targeted assets and our financings;

● attempting to structure our financing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;

● using derivatives, financial futures, swaps, options, caps, floors and forward sales to adjust the interest rate sensitivity of our targeted assets and our borrowings;

● using securitization financing to lower average cost of funds relative to short-term financing vehicles further allowing us to receive the benefit of attractive terms for an extended period of time in contrast to short term financing and maturity dates of the assets included in the securitization; and

● actively managing, on an aggregate basis, the interest rate indices, interest rate adjustment periods, and gross reset margins of our targeted assets and the interest rate indices and adjustment periods of our financings.

Our efforts to manage our assets and liabilities are concerned with the timing and magnitude of the repricing of assets and liabilities. We attempt to control risks associated with interest rate movements. Methods for evaluating interest rate risk include an analysis of our interest rate sensitivity "gap", which is the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category.

The following table sets forth the estimated maturity or repricing of our interest-earning assets and interest-bearing liabilities at September 30, 2012. The amounts of assets and liabilities shown within a particular period were determined in accordance with the contractual terms of the assets and liabilities, except adjustable-rate loans are included in the period in which their interest rates are first scheduled to adjust and not in the period in which they mature and include the effect of the interest rate swaps. The interest rate sensitivity of our assets and liabilities inthe following table could vary substantially based on actual prepayment experience.

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	Within 3			3-12			1 Year to			Greater than
	Months			Months			3 Years			3 Years			Total
Rate sensitive assets, principal balance	$	269,537		$	20,500		$	108,497		$	380,951		$	779,485
Cash and cash equivalents		105,575			-			-			-			105,575
Total rate sensitive assets		375,112			20,500			108,497			380,951			885,060
Rate sensitive liabilities		2,550			-			-			16,600			19,150
Interest rate sensitivity gap	$	372,562		$	20,500		$	108,497		$	364,351		$	865,910
Cumulative rate sensitivity gap	$	372,562		$	393,062		$	501,559		$	865,910
Cumulative interest rate sensitivity
gap as a percentage of total rate
sensitive assets		42.09	%		44.41	%		56.67	%		97.84	%

Our analysis of risks is based on our manager's experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our manager may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in the above tables and in this Form 10-Q. These analyses contain certain forward-looking statements and are subject to the safe harbor statement set forth under the heading, "Special Note Regarding Forward-Looking Statements."

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Item 4.   CONTROLS AND PROCEDURES

Our management, including our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, reviewed and 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 Exchange Act of 1934, as amended (the “Securities Exchange Act”)) as of the end of the period covered by this quarterly report.  Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed and implemented, (1) were effective in ensuring that information regarding the Company and its subsidiaries is made known to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure and (2) were effective in providing reasonable assurance that information the Company must disclose in its periodic reports under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods prescribed by the SEC’s rules and forms.

There have been no changes in our “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Securities Exchange Act) that occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II.                      OTHER INFORMATION

Item 1.   LEGAL PROCEEDINGS

From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial statements.

Item 1A. RISK FACTORS

There have been no material changes to the risk factors discussed in Part I, “Item 1A. Risk Factors” in our most recent Annual Report on Form 10-K. The materialization of any risks and uncertainties identified in our forward looking statements contained in this report together with those previously disclosed in the Form 10-K or those that are presently unforeseen could  result in significant adverse effects on our financial condition, results of operations and cash flows. See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Special Note Regarding Forward-Looking Statements” in this quarterly report on Form 10-Q or our most recent Annual Report on Form 10-K.

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Item 6.    EXHIBITS

Exhibits:

The exhibits required by this item are set forth on the Exhibit Index attached hereto

EXHIBIT INDEX

Exhibit Number	Description
3.1	Articles of Amendment and Restatement of CreXus Investment Corp. (filed as Exhibit 3.1 to the Company’s Registration Statement on Amendment No. 5 to Form S-11 (File No. 333-160254) filed on September 14, 2009 and incorporated herein by reference).
3.2	Amended and Restated Bylaws of CreXus Investment Corp.  (filed as exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q (filed on November 6, 2009) and incorporated herein by reference).
4.1	Specimen Common Stock Certificate of CreXus Investment Corp. (filed as Exhibit 4.1 to the Company’s Registration Statement on Amendment No. 3 to Form S-11 (File No. 333-160254) filed on August 31, 2009 and incorporated herein by reference).
31.1	Certification of Kevin Riordan, Chief Executive Officer and President of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Daniel Wickey, Chief Financial Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of  Kevin Riordan, Chief Executive Officer and President of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Daniel Wickey, Chief Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit 101.INS XBRL Instance Document*

Exhibit 101.SCH XBRL	Taxonomy Extension Schema Document*
Exhibit 101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document*
Exhibit 101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created*
Exhibit 101.LAB XBRL	Taxonomy Extension Label Linkbase Document*
Exhibit 101.PRE XBRL	Taxonomy Extension Presentation Linkbase Document*

*  Submitted electronically herewith.  Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition at September 30, 2012 (Unaudited) and December 31, 2011 (Derived from the audited consolidated statement of financial condition at December 31, 2011); (ii) Consolidated Statements of Comprehensive Income (Unaudited) for the quarters and nine months ended September 30, 2012 and 2011; (iii) Consolidated Statements of Stockholders' Equity (Unaudited) for the nine months ended September 30, 2012 and 2011; (iv) Consolidated Statements of Cash Flows (Unaudited) for the quarters and nine months ended September 30, 2012 and 2011; and (v) Notes to Consolidated Financial Statements (Unaudited) for the quarter ended September 30, 2012.  Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CREXUS INVESTMENT CORP.
By:	/s/ Kevin Riordan
	Kevin Riordan
	Chief Executive Officer and President (Principal Executive Officer)
	November 8, 2012
By:	/s/ Daniel Wickey
	Daniel Wickey
	Chief Financial Officer
	November 8, 2012
By:	/s/ Jack DeCicco
	Jack DeCicco, CPA
	Chief Accounting Officer
	November 8, 2012

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