a50623352.htm

10-Q 1 a50623352.htm CREXUS INVESTMENT CORP. 10-Q a50623352.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2013

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

EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER: 1-34451

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

Common Stock, $.01 par value

Outstanding at May 6, 2013

76,630,528

CREXUS INVESTMENT CORP.

FORM 10-Q

TABLE OF CONTENTS

Part I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements:

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

Consolidated Statements of Comprehensive Income for the Quarters Ended March 31, 2013 and 2012
(Unaudited)	2

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

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

Notes to Consolidated Financial Statements (Unaudited)	5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3. Quantitative and Qualitative Disclosures about Market Risk	44

Item 4. Controls and Procedures	49


Part II. OTHER INFORMATION

Item 1. Legal Proceedings	50

Item 1A. Risk Factors	50

Item 6. Exhibits	51

SIGNATURES	52

CERTIFICATIONS	53

PART I. FINANCIAL INFORMATION

Item 1. CONSOLIDATED FINANCIAL STATEMENTS

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)

	March 31, 2013		December 31, 2012
	(unaudited)		(1)
Assets:
Cash and cash equivalents	$	164,472	$	123,543
Commercial real estate loans net of allowance for loan losses ($0 and $0, respectively)
Senior		100,179		100,343
Subordinate		39,111		38,954
Mezzanine		541,354		590,525
Preferred equity held for investment		39,769		39,769
Real estate held for sale		30,077		33,511
Investment in real estate, net		33,384		33,655
Intangible assets, net		4,989		5,095
Rents receivable		325		268
Accrued interest receivable		4,946		4,957
Other assets		2,866		3,379
Total assets	$	961,472	$	973,999

Liabilities:
Mortgages payable	$	19,150	$	19,150
Participation sold (non-recourse)		13,706		13,759
Accounts payable and other liabilities		2,144		3,363
Dividends payable		19,159		24,522
Intangible liabilities, net		1,873		1,907
Investment management fees payable to affiliate		3,337		3,425
Total liabilities		59,369		66,126

Stockholders' Equity:
Common stock, par value $0.01 per share, 1,000,000,000 shares
authorized, 76,630,528 issued and outstanding		766		766
Additional paid-in-capital		890,862		890,862
Retained earnings		10,475		16,245
Total stockholders' equity		902,103		907,873
Total liabilities and stockholders' equity	$	961,472	$	973,999

(1) Derived from the audited financial statements at December 31, 2012.

See notes to consolidated financial statements.

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except share and per share data)
(unaudited)

	For the Quarter Ended
	March 31, 2013			March 31, 2012

Net interest income:
Interest income	$	21,056		$	23,392
Interest expense		(383	)		(360	)
Servicing fees		(157	)		(115	)
Net interest income		20,516			22,917

Other income:
Miscellaneous fee income		4			349
Rental income		832			712
Total other income		836			1,061

Other expenses:
Provision for loan losses, net		-			2,803
Management fees to affiliate		3,337			3,471
General and administrative expenses		4,370			2,710
Amortization expense		106			123
Depreciation expense		270			275
Total other expenses		8,083			9,382

Income before income tax		13,269			14,596
Income tax		1			1
Net income from continuing operations		13,268			14,595

Net income (loss) from discontinued operations (net of tax expense of $255 and $295, respectively)		(499	)		1,522
Gain on sale from discontinued operations		886			-
Impairment charges		(266	)		-
Total income (loss) from discontinued operations		121			1,522

Net Income	$	13,389		$	16,117

Net income per average share-basic and diluted, continuing operations	$	0.17		$	0.19
Total net income per average share-basic and diluted, discontinued operations		0.00			0.02
Net income per average share-basic and diluted	$	0.17		$	0.21

Dividend declared per share of common stock	$	0.25		$	0.27

Weighted average number of shares outstanding-basic and diluted		76,630,528			76,620,112
Comprehensive income:
Net income	$	13,389		$	16,117
Comprehensive income	$	13,389		$	16,117

See notes to consolidated financial statements.

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
(unaudited)


	Common		Additional
	Stock Par		Paid-in		Retained
	Value		Capital		Earnings			Total
Balance, December 31, 2011	$	766	$	890,757	$	35,634		$	927,157
Net income		-		-		16,117			16,117
Common dividends declared, $0.27 per share		-		-		(20,688	)		(20,688	)
Balance, March 31, 2012	$	766	$	890,757	$	31,063		$	922,586

Balance, December 31, 2012	$	766	$	890,862	$	16,245		$	907,873
Net income		-		-		13,389			13,389
Common dividends declared, $0.25 per share		-		-		(19,159	)		(19,159	)
Balance, March 31, 2013	$	766	$	890,862	$	10,475		$	902,103

See notes to consolidated financial statements.

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
	For the Quarter Ended
	March 31, 2013			March 31, 2012

Cash Flows From Operating Activities:
Net income	$	13,389		$	16,117
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Net amortization of investment premiums and discounts		(582	)		(10,922	)
Amortization of origination fees and costs, net		(120	)		-
Realized gain on sale of real estate held for sale		(886	)		-
Provision for loan losses, net		-			2,803
Impairment charges on real estate held for sale		266			-
Unrealized (gain) loss on interest rate swap		(4	)		41
Amortization of intangible assets and liabilities, net		72			123
Depreciation		270			275
Changes in operating assets:
Decrease (increase) in accrued interest receivable		11			(901	)
Decrease (increase) in other assets		513			(2,119	)
Decrease (increase) in rents receivable		(57	)		(55	)
Changes in operating liabilities:
Increase (decrease) in accounts payable and other liabilities		(1,094	)		407
Increase (decrease) in investment management fee payable to affiliate		(88	)		(18	)
Increase (decrease) in accrued interest payable		-			42
Net cash provided by (used in) operating activities		11,690			5,793
Cash Flows From Investing Activities:
Loans and preferred equity held for investment portfolio:
Purchases and advances, net of discount		(922	)		(116,077	)
Principal payments		50,682			194,277
Real estate portfolio:
Purchases of real estate		-			(5,050	)
Sale of real estate held for sale		4,054			-
Net cash provided by (used in) investing activities		53,814			73,150
Cash Flows From Financing Activities:
Proceeds from collateralized mortgage borrowings		-			2,550
Principal repayments on participation sold		(53	)		-
Dividends paid		(24,522	)		(26,817	)
Net cash (used in) provided by financing activities		(24,575	)		(24,267	)
Net increase (decrease) in cash and cash equivalents		40,929			54,676
Cash and cash equivalents at beginning of period		123,543			202,814
Cash and cash equivalents at end of period	$	164,472		$	257,490
Supplemental disclosure of cash flow information:
Interest paid	$	159		$	48
Taxes paid	$	1,980		$	1
Non cash investing activities:
Reclassification of loans to real estate upon deed in lieu of foreclosure	$	-		$	52,800
Rate and term financing	$	-		$	15,000
Non cash financing activities:
Common dividends declared, not yet paid	$	19,159		$	20,688

See notes to consolidated financial statements.

CREXUS INVESTMENT CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE QUARTER ENDED MARCH 31, 2013

(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.

At March 31, 2013, Annaly Capital Management, Inc. (“Annaly”) owned 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"). The Company adopted the provisions of the Financial Accounting Standards Board (“FASB”), Accounting Standards Codification, (the “Codification” or “ASC”), which is the current source of authoritative GAAP.

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

(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.

The Company's commercial real estate mortgages and loans are comprised of fixed-rate and adjustable-rate loans. Commercial real estate mortgages and loans are designated as held for investment and are carried at their outstanding principal balance, plus premiums, less discounts, which are amortized or accreted over the estimated life of the loan, less an estimated allowance 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.

(d) Preferred Equity Interests Held for Investment

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

(e) 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

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”), Uniform Commercial Code (“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. Upon foreclosure of a property, the excess of the carrying value of a loan, if any, over the estimated fair value of the property, less estimated costs to sell, is charged to provision for loan losses.

Investments in real estate, including REO, which do not meet the criteria to be classified as held for sale, are separately presented in the consolidated statements of financial condition as held for investment. Such operating real estate is reported at cost, or in the case of REO, initially at fair value, less accumulated depreciation. 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 $266 thousand on real estate held for sale for the quarter ended March 31, 2013, 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 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.

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 7.9 years and 9.6 years as of March 31, 2013 and 8.1 years and 9.7 years as of December 31, 2012, respectively.

The following table summarizes identified intangibles as of March 31, 2013 and December 31, 2012:

	March 31, 2013						December 31, 2012
	(dollars in thousands)
	Intangible Assets In- place Leases			Intangible Liabilities Below-market Leases			Intangible Assets In- place Leases			Intangible Liabilities Below-market Leases
Gross amount	$	5,535		$	(2,030	)	$	5,535		$	(2,030	)
Accumulated amortization		(546	)		157			(440	)		123
Net book value	$	4,989		$	(1,873	)	$	5,095		$	(1,907	)

The Company recorded amortization of acquired below-market leases of $34 thousand and $16 thousand for the quarters ended March 31, 2013 and 2012, respectively. Amortization of other intangible assets was $106 thousand and $123 thousand for the quarters ended March 31, 2013 and 2012, respectively.

(f) Allowance for Loan Losses

The Company evaluates the need for a loan loss reserve on its commercial real estate loans. 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 , including those 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 amounts contractually due or 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 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 the fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the competitive landscape 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 consolidated 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 provision for loan loss 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 fair value of the collateral if the loan is collateral dependent.

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.

Loan performance is evaluated and 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 likelihood that the Company may not recover its cost basis.

(g) 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.

(h) Variable Interest Entities

The Company has evaluated all of its investments in order to determine if they qualify as Variable Interest Entities ("VIEs") or as variable interests in VIEs. A VIE is defined as an entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties. A variable interest is an investment or other interest that will absorb portions of a VIE's expected losses or receive portions of the entity’s expected residual returns. A VIE is required to be consolidated by its primary beneficiary, which is defined as the party that (i) has the power to control the activities that most significantly impact the VIE’s economic performance and (ii) has the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

(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 or accreted 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 “Interest income” as an adjustment to loan yield over the life of the loan.

(j) Income Taxes

The Company has elected and is qualified 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 FASB 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 has no unrecognized tax benefits that would affect its financial position. Consequently, no accruals for penalties or interest were recorded during the quarters ended March 31, 2013 and 2012.

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 materially 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 consolidated Statements of Comprehensive Income.

(n) Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation. Origination fees previously reported in miscellaneous fees have been reclassified into interest income in accordance with ASC 310-20, Receivables, Non-Refundable Fees and Other Costs.

(o) Recent Accounting Pronouncements

Broad Transactions

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 for reporting purposes. 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 (REITs) from this topic. If promulgated in its current form, this proposal may result in a material modification to the presentation of the Company’s consolidated financial statements.

On December 12, 2012, the FASB agreed that the accounting for real estate investments should be considered in a second phase of the Investment Companies project and that all REITs should be exempted from conclusions reached in phase I of the project. The Board has not yet agreed on the scope of phase II of the project. The Company is monitoring developments related to this proposal and is evaluating the effects it would have on the Company’s consolidated financial statements.

3. Cash and Cash Equivalents

The Company had $164.5 million and $123.5 million of cash held at independent national banking institutions at March 31, 2013 and December 31, 2012, respectively, and earned $3 thousand in interest income on the Company’s cash balances for the quarters ended March 31, 2013 and 2012, respectively.

4. Commercial Real Estate Loans Held for Investment

The following tables represent the Company's commercial mortgage loans classified as held for investment at March 31, 2013 and December 31, 2012, which are carried at their principal balance outstanding less an allowance for loan losses:

	March 31, 2013							December 31, 2012
					Percentage							Percentage
	Outstanding		Carrying		of Loan			Outstanding		Carrying		of Loan
	Principal		Value		Portfolio(1)			Principal		Value		Portfolio(1)
	(dollars in thousands)
Senior mortgages	$	100,927	$	100,179		14.7	%	$	100,995	$	100,343		13.7	%
Subordinate notes		41,321		39,111		6.0	%		41,410		38,954		5.6	%
Mezzanine loans		545,217		541,354		79.3	%		594,820		590,525		80.7	%
Total	$	687,465	$	680,644		100.0	%	$	737,225	$	729,822		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 real estate loans held for investment for the quarter ended March 31, 2013:

	March 31, 2013
	Senior			Subordinate			Mezzanine
	Mortgages			Notes			Loans			Total
	(dollars in thousands)
Beginning principal balance, net of allowance for loan losses	$	100,995		$	41,410		$	594,820		$	737,225
Purchases\advances, principal balance		-			-			922			922
Remaining discount		(748	)		(2,210	)		(3,863	)		(6,821	)
Principal payments		(68	)		(89	)		(50,525	)		(50,682	)
Principal write-off		-			-			-			-
Transfers to real estate held for sale		-			-			-			-
		100,179			39,111			541,354			680,644
Recovery (allowance) for loan losses		-			-			-			-
Commercial mortgage loans held for investment	$	100,179		$	39,111		$	541,354		$	680,644

At March 31, 2013 and December 31, 2012 the Company had no loans remaining in its portfolio that were acquired with evidence of a deterioration in credit quality accounted for pursuant to ASC Subtopic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.

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 quarters ended March 31, 2013 and 2012, respectively, which were accounted for pursuant to ASC Subtopic 310-30:

	Accretable Yield
	March 31, 2013				March 31, 2012
	Accretable Yield		Carrying Value of the Loans		Accretable Yield			Carrying Value of the Loans
	(dollars in thousands)
Beginning balance	$	-	$	-	$	13,259		$	257,065
Accretion		-		-		(8,030	)		8,030
Collections		-		-		-			(154,000	)
Disposition/transfers		-		-		(1,126	)		(53,865	)
Decrease in cashflow estimates		-		-		(2,933	)		-
Ending balance	$	-	$	-	$	1,170		$	57,230

The following table summarizes the changes in the allowance for loan losses for the commercial mortgage loan portfolio for the three months and year ended March 31, 2013 and December 31, 2012, respectively.

	March 31, 2013		December 31, 2012
	(dollars in thousands)

Balance, beginning of period	$	-	$	369
Reversal		-		(369	)
Provision for loan loss		-		3,172
Charge-offs		-		(3,172	)

Balance, end of period	$	-	$	-

The following tables present certain characteristics of the Company’s commercial mortgage loan portfolio as of March 31, 2013 and December 31, 2012, respectively.

March 31, 2013
Geographic Distribution					Property
Top 5 States	Remaining Balance		% of Loans (1)		Count
(dollars in thousands)
Texas	$	150,598	21.9	%		167
New York		88,800	12.9	%		9
Illinois		83,352	12.1	%		125
Georgia		62,044	9.0	%		65
California		58,832	8.6	%		152

December 31, 2012
Geographic Distribution					Property
Top 5 States	Remaining Balance		% of Loans (1)		Count
(dollars in thousands)
Texas	$	155,505	21.1	%		170
New York		90,453	12.3	%		10
Illinois		85,691	11.6	%		128
Georgia		64,325	8.7	%		69
California		63,461	8.6	%		156

(1)	Percentages based on outstanding principal balance of the commercial real estate loan portfolio of $687.5 million and $737.2 million at March 31, 2013 and December 31, 2012, respectively.

March 31, 2013

Property Type	Number of Assets		Outstanding Principal		% of Total
	(dollars in thousands)
Retail		8	$	224,383		33	%
Office		13		242,609		35	%
Hotel		5		107,000		15	%
Industrial		4		100,500		15	%
Condominium		1		12,973		2	%
Total		31	$	687,465		100	%

December 31, 2012

Property Type	Number of Assets		Outstanding Principal		% of Total
	(dollars in thousands)
Retail		9	$	264,652		36	%
Office		13		252,100		34	%
Hotel		5		107,000		14	%
Industrial		4		100,500		14	%
Condominium		1		12,973		2	%
Total		32	$	737,225		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 March 31, 2013 and December 31, 2012. At March 31, 2013, two loans were designated as Watch List. The following table presents the loan type and internal ratings for the loans as of March 31, 2013 and December 31, 2012.

March 31, 2013

			Percentage			Internal Ratings
	Outstanding		of Loan			Performing		Watch List			Workout
Investment type	Principal		Portfolio			Loans		Loans			Loans
	(dollars in thousands)
Senior mortgages	$	100,927		14.7	%	$	87,954	$	12,973	(1)	$	-
Subordinate notes		41,321		6.0	%		41,321		-			-
Mezzanine loans		545,217		79.3	%		501,217		44,000			-
	$	687,465		100.0	%	$	630,492	$	56,973		$	-

(1) Loan on non-accrual status. Amount represents recorded investment in the loan.

December 31, 2012

			Percentage			Internal Ratings
	Outstanding		of Loan			Performing		Watch List		Workout
Investment type	Principal		Portfolio			Loans		Loans		Loans
	(dollars in thousands)
Senior mortgages	$	100,995		13.7	%	$	88,022	$	-	$	12,973	(1)
Subordinate notes		41,410		5.6	%		41,410		-		-
Mezzanine loans		594,820		80.7	%		550,820		44,000		-
	$	737,225		100.0	%	$	680,252	$	44,000	$	12,973

(1) Loan on non-accrual status. Amount represents recorded investment in the loan.

5. Preferred Equity Held for Investment

The following table represents the Company's preferred equity held for investment at March 31, 2013 and December 31, 2012, which is carried at its principal balance outstanding less an allowance for losses:

	March 31, 2013		December 31, 2012
	(dollars in thousands)
Beginning balance	$	39,769	$	-
Purchases, principal balance		-		39,769

Preferred equity held for investment	$	39,769	$	39,769

The Company had no allowance for losses related to its preferred equity investment at March 31, 2013 and December 31, 2012.

The Company’s preferred equity portfolio had a principal balance outstanding of $39.8 million as of March 31, 2013, that consisted of one investment secured by the equity in ten multifamily properties located in the suburban Baltimore and Washington, D.C. area.

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

At March 31, 2013 and December 31, 2012, investment in real estate, net consists of the following:

	March 31, 2013			December 31, 2012
	(dollars in thousands)

Land	$	7,490		$	7,490
Buildings and improvements		27,304			27,305
Subtotal		34,794			34,795
Less: Accumulated depreciation		(1,410	)		(1,140	)
Investments in real estate, net	$	33,384		$	33,655

For the quarters ended March 31, 2013, and 2012, depreciation expense was $270 thousand, and $275 thousand, respectively.

Real Estate Acquisitions

The Company did not acquire real estate during the quarter ended March 31, 2013. During the quarter ended March 31, 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 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 during the quarter ended March 31, 2012, the Company recorded $318 thousand in intangible assets and $421 thousand of intangible liabilities.

The supplemental pro forma financial information set forth below is based upon the Company's historical consolidated statements of comprehensive income for quarter ended March 31, 2012 to give effect to the above transactions as of January 1, 2012.

	Business Combinations Actual
	For the Quarter Ended March 31,				Proforma Consolidated for
	2013		2012		The Quarter Ended March 31, 2012
	(dollars in thousands, except per share data)
Revenues	$	832	$	712	$	23,978
Net income	$	250	$	120	$	16,237
Net income per average common share - basic/diluted	$	0.00	$	0.00	$	0.21

The supplemental pro forma financial information above 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, 2012, nor does it purport to represent the results of future operations.

For the quarter ended March 31, 2012, the Company acquired the following real estate in connection with a deed-in-lieu of foreclosure:

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 quarter ended March 31, 2012 is classified as real estate held for sale, and is unencumbered by contractual debt obligations. The working capital related to assets classified as held for sale is comprised of $3.9 million in current assets and $2.6 million in current liabilities at March 31, 2013. The net working capital of $1.3 million is included in other assets in the consolidated statement of financial condition.

During the quarter ended March 31, 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 operations of real estate classified as held for sale on the consolidated statements of financial condition are reported as discontinued operations. The following table summarizes the components of income from discontinued operations for the quarters ended March 31, 2013 and 2012:

	Quarter Ended
	March 31, 2013			March 31, 2012
Revenue:	(dollars in thousands)
Operating income	$	3,661		$	6,679

Expenses:
Property operating expenses		3,905			4,862

Pretax (loss) earnings		(244	)		1,817

Income tax		255			295

Total net (loss) income from discontinued operations	$	(499	)	$	1,522

During the quarter ended March 31, 2013 the Company recognized approximately $266 thousand of impairment charges related to two assets classified as held for sale. The impairment charges are measured as the excess of the carrying value of the individual asset over the estimated sale price less estimated costs to sell.

Disposition of Assets Held for Sale

During the quarter ended March 31, 2013, the Company sold one hotel resulting in proceeds of approximately $4.1 million. The sale transaction resulted in a net pre-tax gain of approximately $886 thousand.

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 statements of financial condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques as follows:

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

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

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

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

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.

Interest Rate Swap

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:

	March 31, 2013

	Level 1		Level 2		Level 3
	(dollars in thousands)
Liabilities:
Interest Rate Swap	$	-	$	85	$	-

	December 31, 2012

	Level 1		Level 2		Level 3
	(dollars in thousands)
Liabilities:
Interest Rate Swap	$	-	$	89	$	-

Financial Asset 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 discounted 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.

The carrying value of commercial real estate loans totaled $680.6 million and $729.8 million at March 31, 2013 and December 31, 2012, respectively. These loans are held for investment and are recorded at amortized cost less an allowance for losses. The estimated fair value of these loans is $690.6 million and $736.6 million as of March 31, 2013 and December 31, 2012, respectively. 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 or purchased.

Preferred equity investments totaled $39.8 million at March 31, 2013 and December 31, 2012. The preferred equity investment is recorded at amortized cost less an allowance for losses. The estimated fair value of this investment is $39.1 million and $39.3 million as of March 31, 2013 and December 31, 2012, respectively. 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.

The carrying value of mortgages payable totaled $19.2 million, and $19.2 million at March 31, 2013 and 2012, respectively. The fair value of the Company’s mortgage loans at March 31, 2013 and 2012 totaled $19.4 million, and $19.4 million, respectively. The fair value of mortgages payable is based on the related contractual cash flows and estimated changes in the yield curve from the time of origination. The fair value of mortgages payable also reflects consideration of the value of the underlying collateral and changes in credit risk from the time the debt was originated.

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

		March 31, 2013				December 31, 2012
		Carrying Value		Fair Value		Carrying Value		Fair Value
	Level in Fair Value	(dollars in thousands)
Financial assets:	Hierarchy
Cash and cash equivalents	1	$	164,472	$	164,472	$	123,543	$	123,543
Commercial real estate investments:
Senior	3		100,179		101,495		100,343		99,999
Subordinate	3		39,111		41,879		38,954		42,078
Mezzanine	3		541,354		547,178		590,525		594,554
Preferred equity	3		39,769		39,060		39,769		39,256

Financial liabilities:
Mortgage payable	2		19,150		19,447		19,150		19,407
Participations sold	3		13,706		14,373		13,759		14,525
Interest rate swap liability	2		85		85		89		89

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.

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

Real estate held for sale totaled $30.1 million at March 31, 2013 and is recorded at its estimated fair value less costs to sell (considered to be Level 3 in the fair value hierarchy). During the quarter ended March 31, 2013, the Company recognized impairment charges of approximately $266 thousand related to two hotels. The fair value and related impairment of these hotels was based on an executed purchase and sale agreement.

8. Income Taxes

For the quarter ended March 31, 2013 the Company is qualified to be taxed as a REIT. 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 distribution requirements 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 quarters ended March 31, 2013 and 2012, the Company recorded estimated federal and state income tax expense related to earnings of its TRS in the amount of $309 thousand and $295 thousand, respectively, which is primarily attributable to income from discontinued operations of hotels acquired during 2012 via deed in lieu of foreclosure. This amount is recorded as a component of net income (loss) 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.

During February of 2012 the Company took possession of a portfolio of hotels in connection with a deed-in-lieu of foreclosure and recorded a deferred tax asset (“DTA”) of approximately $900 thousand for the difference between the tax and GAAP basis of the related assets. At that time the Company recorded a valuation allowance against the entire DTA due to uncertainty regarding the Company’s ability to realize the DTA. During the fourth quarter of 2012, based on updated available information, the Company determined that the remaining DTA, as reduced during the year for sales of hotels, was realizable, and the Company reversed the entire remaining valuation allowance of approximately $600 thousand. This resulted in the recognition of an income tax benefit of approximately $600 thousand during the fourth quarter of 2012, which is recorded as a component of net income (loss) from discontinued operations in the consolidated statement of comprehensive income.

During the quarter ended March 31, 2013, the DTA was increased by $54 thousand as a result of the sale of a hotel and the recognition of impairment on two of the remaining unsold hotels during the quarter. This resulted in the recognition of a net $54 thousand income tax benefit during the quarter ended March 31, 2013, which is recorded as a component of net income (loss) from discontinued operations in the consolidated statement of comprehensive income.

9. Common Stock

During the quarter ended March 31, 2013, the Company declared dividends to common shareholders totaling $19.2 million or $0.25 per share which was paid to shareholders on April 25, 2013. During the quarter ended March 31, 2012, the Company declared dividends to common shareholders totaling $20.7 million or $0.27 per share which was paid to shareholders on April 26, 2012. Dividends declared and paid to common shareholders for the quarters ended March 31, 2013 and 2012 are expected to be characterized as ordinary income for federal tax purposes.

10. Equity Incentive Plan

The Company has adopted an equity incentive plan to provide incentives to its independent directors, employees of FIDAC and its affiliates, including Annaly, and other service providers to stimulate their efforts toward the Company’s 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.

The Company issued approximately 10,000 shares, approximating $105 thousand, to the independent members of the Board of Directors during the year ended December 31, 2012. The shares were granted and vested on May 24, 2012.

The independent directors of the Company receive fees for their service as a director of the Company or as the chairman of the Board or a Board committee. Any member of the Board who is also an employee of the Manager is not considered independent and does not receive additional compensation for serving on the Board. For 2012, the equity compensation portion of the compensation for serving on the Board consisted of an equity grant of in the form of deferred stock units with a value of $35,000 per independent director. For 2013, the equity compensation portion of the compensation for serving on the Board will be a $50,000 equity grant per independent director; however, any equity-based compensation will be settled in cash at the closing of the Merger (as defined below), if applicable.

11. Debt Obligations

The Company has two first mortgages outstanding with aggregate principal balances as of March 31, 2013 and December 31, 2012 as follows:

				Outstanding Balance
Maturity	Type	Fixed Interest rate/spread over 1 Month LIBOR (1)		March 31, 2013		December 31, 2012
				(dollars in thousands)
2016	Fixed		3.50	$	16,600	$	16,600

2017 (2)	Variable		2.20		2,550		2,550
				$	19,150	$	19,150

(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.

The first mortgages are collateralized by two distribution/warehouse centers. 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 quarters ended March 31, 2013 and 2012 was $173 thousand and $186 thousand, respectively.

12. Management Agreement and Related Party Transactions

Management Agreement

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 equal to the sum of net proceeds from any issuance of the Company’s equity securities since inception, consolidated retained earnings (excluding non-cash equity compensation), less any amount the Company pays for repurchases of its common stock, 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 $3.3 million, and $3.4 million, respectively, for the quarters ended March 31, 2013 and 2012.

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.

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.

Amendment to the Management Agreement

On January 30, 2013, the Company and FIDAC entered into an amendment to the management agreement pursuant to which, FIDAC has agreed to, among other things, in good faith facilitate and assist the Company in its efforts to actively seek and solicit acquisition proposals during the Transaction Solicitation Period (as defined in the Merger Agreement (as defined below)) and, following the conclusion of the Transaction Solicitation Period, in good faith facilitate and assist the Company’s discussions, negotiations, providing of information and any other permissible action with respect to possible acquisition proposals under the terms of the Merger Agreement. The amendment also shortens the notice provision for the Company’s termination of the management agreement from 180 days to 60 days’ notice at any time during the first six months following the acquisition by a third party of a majority of the Company’s stock or assets.

Agreement and Plan of Merger

On January 30, 2013, the Company entered into the Agreement and Plan of Merger (or the Merger Agreement), among the Company, Annaly and CXS Acquisition Corporation (a wholly-owned subsidiary of Annaly) (or Acquisition), pursuant to which, among other things, Acquisition would commence a tender offer (or the Offer) to purchase all of the outstanding shares of the Company’s common stock, par value $0.01 per share (or the Shares), that Acquisition or Annaly did not own at a price per share of $13.05206, which reflects a price of $13.00 in cash, plus a cash payment to reflect a pro-rated quarterly dividend for the quarter in which the Offer was consummated, subject to the terms and conditions set forth in the Merger Agreement.

As of March 31, 2013 and December 31, 2012 Annaly owned approximately 12.4% of the Company’s outstanding shares.

RCap Securities Inc.

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 periods ended March 31, 2013 and 2012 the Company paid RCap approximately $9 thousand and $8 thousand, respectively, 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 under ASC 450, Contingencies, as of March 31, 2013 and December 31, 2012.

The Company agreed to pay the underwriters of the Company’s 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 Company’s initial public offering certain performance hurdles were met. During the year ended December 31, 2012 the Company paid the underwriters $2.0 million, representing the full amount due, as a result of meeting the required hurdle.

The Special Committee of the Board of Directors of the Company has retained Lazard Frères & Co LLC (“Lazard”) to act as the sole investment banker to the Special Committee of the Board of Directors of the Company with respect to a variety of matters, including without limitation any transaction in which the Company engages in a merger, sale, divestiture, spinoff or liquidation of the Company (a “Transaction”). The Company has agreed to pay Lazard a fee for such services in the amount of 0.65% of the aggregate consideration (as defined in Lazard’s engagement letter) in the Transaction, $250,000 of which was paid to Lazard as a retainer, $1,500,000 of which was paid to Lazard upon the rendering of Lazard’s opinion and the remainder of which is contingent upon the closing of the Transaction.

14. Participations Sold

Participations sold represent interests in loans that the Company purchased and subsequently sold to third-parties that did not qualify as sales under ASC 860, Transfers. The Company presents 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 the consolidated statements of financial condition, and an equivalent amount of interest income and interest expense is recorded on the consolidated statements of comprehensive income. However, impaired loan assets, if any, 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. The Company has no economic exposure to these liabilities.

The following table summarizes the Company’s participations sold assets and liabilities as of March 31, 2013 and December 31, 2012:

	March 31, 2013		December 31, 2012
	(dollars in thousands)
Participations sold assets
Gross carrying value	$	13,706	$	13,759
Less: Provision for loan losses		-		-
Net book value of assets	$	13,706	$	13,759

Liabilities
Net book value of liabilities	$	13,706	$	13,759
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 March 31, 2013 and December 31, 2012, the Company had one interest rate swap outstanding which has not been designated as a hedging instrument for accounting purposes.

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 March 31, 2013, and the amount of income (expense) recognized during the year ended December 31, 2012:

	Location in Consolidated Statements of Financial Condition	Location in Consolidated Statements of Comprehensive Income	Notional Amount		Fair Value Net Asset (Liability)			Interest Income (Expense) on Interest Rate Swaps			Unrealized Gains (Losses) on Interest Rate Swaps
	(dollars in thousands)
March 31, 2013	Accounts payable and other liabilities	Interest Expense		2,550		(85	)		(5	)		(85	)

December 31, 2012	Accounts payable and other liabilities	Interest Expense		2,550		(89	)		(29	)		(89	)

The Company's counterparty held no cash margin as collateral against the Company's derivative contract as of March 31, 2013 and December 31, 2012.

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 quarters ended March 31, 2013 and 2012, respectively, are computed as follows:

	For the Quarter Ended

	March 31, 2013		March 31, 2012
	(dollars in thousands)
Numerator:
Net income	$	13,389	$	16,117
Effect of dilutive securities:		-		-
Dilutive net income available to stockholders	$	13,389	$	16,117

Denominator:
Weighted average shares available to common stockholders		76,630,528		76,620,112
Weighted Average Dilutive Shares		-		-
Net income per average share attributable to common stockholders - Basic/Diluted	$	0.17	$	0.21

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 ended March 31, 2013 and 2012, respectively.

	For the Quarter Ended March 31, 2013

	Corporate/ Unallocated			Debt Investments			Real Estate Investments			Consolidated Total
							(dollars in thousands)
Net interest income:
Interest income	$	-		$	21,056		$	-		$	21,056
Interest expense		-			(209	)		(174	)		(383	)
Servicing fees		-			(157	)		-			(157	)
Net interest income (expense)		-			20,690			(174	)		20,516

Other income:
Miscellaneous fee income		-			4			-			4
Rental income		-			-			832			832
Total other income		-			4			832			836

Other expenses:
Management fees to affiliate		3,337			-			-			3,337
General and administrative expenses		4,128			7			235			4,370
Amortization Expense		-			-			106			106
Depreciation expense		-			-			270			270
Total other expenses		7,465			7			611			8,083


Net (loss) income before income tax		(7,465	)		20,687			47			13,269

Income tax		1			-			-			1

(Loss) income from continuing operations		(7,466	)		20,687			47			13,268

Net (loss) income from discontinued operations (net of tax expense of $255)		-			-			(499	)		(499	)
Gain on sale from discontinued operations		-			-			886			886
Impairment charges		-			-			(266	)		(266	)
Total (loss) income from discontinued operations		-			-			121			121

Net (loss) income	$	(7,466	)	$	20,687		$	168		$	13,389

Total assets	$	491		$	881,964		$	79,017		$	961,472


	For the Quarter Ended March 31, 2012

	Corporate/ Unallocated			Debt Investments			Real Estate Investments			Consolidated Total
							(dollars in thousands)
Net interest income:
Interest income	$	-		$	23,392		$	-		$	23,392
Interest expense		-			(174	)		(186	)		(360	)
Servicing fees		-			(115	)		-			(115	)
Net interest income (expense)		-			23,103			(186	)		22,917

Other income:
Rental income		-			-			712			712
Miscellaneous fee income		-			349			-			349
Total other income		-			349			712			1,061

Other expenses:
Provision loan losses, net		-			2,803			-			2,803
Management fees to affiliate		3,471			-			-			3,471
General and administrative expenses		1,229			1,379			102			2,710
Depreciation expense		-			-			275			275
Amortization Expense		-			-			123			123
Total other expenses		4,700			4,182			500			9,382

Net (loss) income before income tax		(4,700	)		19,270			26			14,596

Income tax		1			-			-			1

(Loss) income from continuing operations		(4,701	)		19,270			26			14,595

Net (loss) income from discontinued operations (net of tax expense of $295)		-			-			1,522			1,522

Net (loss) income	$	(4,701	)	$	19,270		$	1,548		$	16,117

Total assets	$	618		$	887,726		$	99,047		$	987,391

18. Subsequent Events

Pursuant to the terms of the Merger Agreement, on March 18, 2013, Annaly commenced the Offer to purchase all of the outstanding shares that Acquisition or Annaly did not own at a price per share of $13.05206, which reflects a price of $13.00 in cash, plus a cash payment to reflect a pro-rated quarterly dividend for the quarter in which the Offer was consummated, subject to the terms and conditions set forth in the Merger Agreement.

The Offer expired at 5:00 p.m., New York City Time on April 16, 2013. The depository for the Offer has advised Annaly and Acquisition that, as of such time, an aggregate of approximately 55,225,336 Shares were tendered into, and not withdrawn from, the Offer (including 2,318,138 Shares tendered by notices of guaranteed delivery) representing approximately 82.3% of the outstanding Shares not previously held by Annaly. Acquisition accepted for payment all Shares that were validly tendered and not properly withdrawn, and payment was made promptly, in accordance with the terms of the Offer. The depository subsequently informed the Company that only 2,153,224 of the 2,318,138 Shares tendered by notices of guaranteed delivery were actually delivered. This resulted in a total number of 55,060,422 Shares being tendered into, and not withdrawn from, the Offer representing approximately 82.1% of the outstanding Shares not previously held by Annaly.

Following the expiration of the Offer, Acquisition exercised the percentage increase option, pursuant to the terms of the Merger Agreement, to purchase directly from the Company the number of Shares that represent the number of Shares sufficient, when added to the number of Shares purchased by Acquisition in the Offer, to give Acquisition ownership of one Share more than 90% of the Company’s then outstanding Shares.

Acquisition will be merged with and into the Company in a transaction in which each share of the Company's common stock that was not tendered, except shares owned by the Company or Acquisition, will be converted into the right to receive $13.05206, in cash, subject to any required withholding taxes. Because Annaly will own, through Acquisition, more than 90% of the stock of the Company, the merger will not have to be approved by the Company’s stockholders. The Company intends to complete the merger with Acquisition on May 23, 2013.

As of May 6, 2013, Annaly, through Acquisition, owns approximately 84.3% of the Company’s outstanding shares.

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 consummate the transaction contemplated by the agreement and plan of merger with Annaly Capital Management, Inc. and its subsidiary CXS Acquisition Corporation, pursuant to which Annaly would purchase all of our outstanding shares of common stock (other than shares owned by Annaly);

●

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.

Except where expressly stated otherwise, forward-looking statements contained in this report do not reflect changes to our business, financial condition, liquidity, results of operations, plans and objectives that may occur as a result of the closing of the Merger Agreement (as defined below) with Annaly Capital Management, Inc.

All references to “we,” “us,” or “our” mean CreXus Investment Corp. and all entities owned by us, except where it is made clear that the term means only the parent company.

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 transactions and we may in invest in build-to-suit transactions for companies in the U.S. 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.

Agreement and Plan of Merger

On January 30, 2013, the Company entered into the Agreement and Plan of Merger (or the Merger Agreement), among the Company, Annaly and CXS Acquisition Corporation (a wholly-owned subsidiary of Annaly) (or Acquisition), pursuant to which, among other things, Acquisition would commence a tender offer (or the Offer) to purchase all of the outstanding shares of the Company’s common stock, par value $0.01 per share (or the Shares), that Acquisition or Annaly did not own at a price per share of $13.05206, which reflects a price $13.00 in cash, plus a cash payment to reflect a pro-rated quarterly dividend for the quarter in which the Offer was consummated, subject to the terms and conditions set forth in the Merger Agreement.

Pursuant to the terms of the Merger Agreement, Annaly commenced the Offer on March 18, 2013. The Offer expired at 5:00 p.m., New York City Time on April 16, 2013. The depository for the Offer has advised Annaly and Acquisition that, as of such time, an aggregate of approximately 55,225,336 Shares were tendered into, and not withdrawn from, the Offer (including 2,318,138 Shares tendered by notices of guaranteed delivery) representing approximately 82.3% of the outstanding Shares not previously held by Annaly. Acquisition accepted for payment all Shares that were validly tendered and not properly withdrawn, and payment was made promptly, in accordance with the terms of the Offer. The depository subsequently informed the Company that only 2,153,224 of the 2,318,138 Shares tendered by notices of guaranteed delivery were actually delivered. This resulted in a total number of 55,060,422 Shares being tendered into, and not withdrawn from, the Offer representing approximately 82.1% of the outstanding Shares not previously held by Annaly.

Following the expiration of the Offer, Acquisition exercised the percentage increase option, pursuant to the terms of the Merger Agreement, to purchase directly from the Company the number of Shares that represented the minimum number of Shares sufficient, when added to the number of Shares purchased by Acquisition in the Offer, to give Acquisition ownership of one Share more than 90% of the Company’s then outstanding Shares.

Acquisition will be merged with and into the Company in a transaction in which each share of the Company common stock that was not tendered, except shares owned by the Company or Acquisition, will be converted into the right to receive $13.05206, in cash, subject to any required withholding taxes. Because Annaly will own, through Acquisition, more than 90% of the stock of the Company, the merger will not have to be approved by the Company’s stockholders. The Company intends to complete the merger with Acquisition on May 23, 2013.

As of May 6, 2013, Annaly, through Acquisition, owns approximately 84.3% of the Company’s outstanding shares.

Our Investment Strategy

●	Commercial Mortgage Loans:

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

Construction loans

●	Subordinated Debt and Preferred Equity:

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

Mezzanine loans

Loan participations

Preferred equity

●	Commercial Real Property:

Office buildings

Hotels

Retail

Industrial

Multifamily

Residential condominiums

Other commercial real property including land

●	Commercial Mortgage-Backed Securities, or CMBS:

CMBS rated AAA through BBB

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

●	Other Commercial Real Estate Assets:

Debt and equity tranches of CRE CDOs

Loans to real estate companies including REITs and REOCs

Commercial real estate securities

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 may 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 respective properties. 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.

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 accretion of purchase discount. Interest rates vary according to the type of asset, conditions in the financial markets, creditworthiness of our borrowers, competition and other factors, none of which can be predicted with certainty. Accretion of purchase discount is calculated using the effective interest method and is dependent on price of the asset and the duration that the asset matures. 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.

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 ability of the asset to refinance. 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.

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 likelihood that we may not recover our cost basis.

Size of Portfolio. The size of our portfolio, as measured by the aggregate unpaid principal balance of our commercial real estate loans, aggregate principal balance of our mortgage-related securities and our investment in real estate are the key revenue drivers. Generally, as the size of our portfolio grows, the amount of interest and rental 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.

Investment Activities

At March 31, 2013, our investment portfolio consisted of $680.6 million of loans, $39.8 million of preferred equity and $66.6 million of equity investments in real estate, which includes real estate held for sale and is net of intangible assets and liabilities relating to the purchase price allocation of the investment in real estate of $3.1 million.

The following table summarizes certain characteristics of our investment portfolio at March 31, 2013 and December 31, 2012:

	March 31, 2013			December 31, 2012
Commercial Real Estate Debt and Preferred Equity Portfolio	(dollars in thousands)
Commercial real estate debt and preferred equity investment portfolio	$	720,413		$	769,591
Participation sold		13,706			13,759
Fixed-rate investments as percentage of portfolio		70	%		71	%
Adjustable rate investments as percentage of portfolio		30	%		29	%
Fixed-rate investments
Commercial real estate debt as percentage of fixed-rate assets		92	%		93	%
Commercial preferred equity as percentage of fixed-rate assets		8	%		7	%
Adjustable rate investments
Commercial mortgage loans as percentage of adjustable-rate assets		100	%		100	%
Weighted average yield on interest earning assets at period-end		10.41	%		10.56	%

Real Estate Properties Portfolio including Real Estate Held for Sale
Real estate investment at period-end (1)	$	66,577		$	70,354
Financing on real estate	$	19,150		$	19,150
Annualized yield on real estate investment portfolio at period end (2)		0.97	%		9.55	%
Weighted average cost of funds on real estate investment financing(3)		3.49	%		3.49	%

(1)	Includes $30.1 million and $33.5 million in real estate held for sale at March 31, 2013 and December 31, 2012, respectively. Also includes related net intangible assets in excess of liabilities associated with purchase price allocation.
(2)	Impairment charges and gain or loss on sales related to discontinued operations were not annualized for purposes of determining the yield on real estate investment portfolio.
(3)	Includes the effect of the interest rate swap and excludes the effect of the change in market value of the interest rate swap for the quarters ended March 31, 2013 and December 31, 2012.

The following table represents our commercial real estate loan and preferred equity portfolio at March 31, 2013:

Commercial Real Estate Loans and Preferred Equity
March 31, 2013
(dollars in thousands)

Property Type						Stated	Payment			Carrying
Senior Debt		Location	Coupon			Maturity Date	Terms	Face Amount		Amount
	Condo	NY		-	%(1)	Dec-13	I/O	$	12,973	$	12,973
	Retail	CO		5.58	%	May-17	30 year		17,640		15,648
	Retail	IN		4.75	%	Nov-14	I/O		23,814		23,814
	Industrial	TX		6.40	%	Aug-14	I/O		34,000		35,244
	Retail	PA		4.50	%	Aug-15	I/O		12,500		12,500
Commercial mortgage loans: weighted average coupon				4.81	%	Commercial mortgage loans total		$	100,927	$	100,179

Subordinate and Mezzanine debt (2)

	Hotel	TX		10.53	%	Sep-16	I/O	$	44,000	$	44,000
	Retail	TX		11.25	%	Apr-15	30 year		27,072		27,072
	Office	NY		10.00	%	Jul-21	I/O		10,000		10,000
	Office	NY		10.00	%	Dec-14	Fully Amortizing		3,493		3,493
	Retail	Various		7.71	%	Dec-15	Fixed paydown		45,475		42,900
	Office	CA		11.13	%	Oct-14	I/O		20,000		20,000
	Office	GA		12.17	%	Oct-13	I/O		20,500		20,500
	Office	IL		5.64	%	Jan-15	30 year		16,321		15,703
	Office	IL		6.66	%	Jun-15	I/O		25,000		23,408
	Office	NY		11.15	%	Sep-21	I/O		18,000		18,000
	Retail	Various		11.25	%	Apr-17	25 year		87,103		87,103
	Hotel	CA		12.25	%	Apr-17	I/O		8,000		8,000
	Industrial	Various		11.15	%	Jun-17	I/O		50,000		50,000
	Office	MD		11.20	%	Aug-17	I/O		10,130		10,130
	Office	MD		11.70	%	Aug-17	I/O		9,942		9,942
	Office	GA		11.00	%	Jul-15	I/O		9,000		9,000
	Hotel	Various		11.50	%	Dec-19	I/O		25,000		25,000
	Office	NY		10.00	%	Oct-18	I/O		10,000		10,000
	Industrial	NY		11.50	%	Jan-18	I/O		4,000		4,000
	Office	Various		11.50	%	Dec-14	I/O		82,953		82,953
	Retail	IN		16.22	%	Nov-14	I/O		4,779		4,779
	Hotel	NY		10.83	%	Sep-13	I/O		17,000		17,000
	Hotel	NY		12.61	%	Sep-13	I/O		13,000		13,000
	Office	IL		12.25	%	Aug-15	I/O		7,270		7,270
	Industrial	TX		6.40	%	Aug-14	I/O		12,500		11,212
	Retail	PA		11.75	%	Aug-15	I/O		6,000		6,000
Subordinate and mezzanine debt: weighted average coupon				10.57	%	Subordinate and mezzanine debt total		$	586,538	$	580,465
Total debt portfolio: weighted average coupon				9.73	%	Total debt portfolio		$	687,465	$	680,644

Preferred Equity
	Multi-Family PE	MD		11.00	%	Aug-22	I/O	$	39,769	$	39,769
Commercial real estate debt and preferred equity portfolio: weighted average coupon				9.80	%	Total commercial real estate debt and prefered equity portfolio		$	727,234	$	720,413

(1) Loan on non-accrual status as of March 31, 2013.

(2) Subject to prior liens.

Results of Operations

Net Income Summary

Our net income for the quarter ended March 31, 2013 was $13.4 million, or $0.17 per average common share, as compared to $16.1 million or $0.21 per average common share for the quarter ended March 31, 2012. We attribute the decrease in net income for the quarter ended March 31, 2013 to a decrease in net interest income of $2.4 million, a $1.7 million increase in general & administrative expenses, a $1.4 million decrease related to the net results of components of discontinued operations, which were partially offset by a decrease in the provision for loan loss of $2.8 million. The table below presents the Consolidated Statements of Operations and Comprehensive Income for the quarters ended March 31, 2013 and 2012:

CREXUS INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except share and per share data)
(unaudited)

	For the Quarter Ended
	March 31, 2013			March 31, 2012

Net interest income:
Interest income	$	21,056		$	23,392
Interest expense		(383	)		(360	)
Servicing fees		(157	)		(115	)
Net interest income		20,516			22,917

Other income:
Miscellaneous fee income		4			349
Rental income		832			712
Total other income		836			1,061

Other expenses:
Provision for loan losses, net		-			2,803
Management fees to affiliate		3,337			3,471
General and administrative expenses		4,370			2,710
Amortization expense		106			123
Depreciation expense		270			275
Total other expenses		8,083			9,382

Income before income tax		13,269			14,596
Income tax		1			1
Net income from continuing operations		13,268			14,595

Net income (loss) from discontinued operations (net of tax expense of $255 and $295, respectively)		(499	)		1,522
Gain on sale from discontinued operations		886			-
Impairment charges		(266	)		-
Total income (loss) from discontinued operations		121			1,522

Net Income	$	13,389		$	16,117

Net income per average share-basic and diluted, continuing operations	$	0.17		$	0.19
Total net income per average share-basic and diluted, discontinued operations		0.00			0.02
Net income per average share-basic and diluted	$	0.17		$	0.21

Dividend declared per share of common stock	$	0.25		$	0.27

Weighted average number of shares outstanding-basic and diluted		76,630,528			76,620,112
Comprehensive income:
Net income	$	13,389		$	16,117
Comprehensive income	$	13,389		$	16,117

Interest Income and Average Earning Asset Yield

We had average interest-earning assets of $748.8 million and $689.2 million for the quarters ended March 31, 2013 and 2012, respectively. Average interest-earning assets for the quarter ended March 31, 2013 increased when compared to March 31, 2012 primarily as a result of funding loans during the year ended December 31, 2012. Our interest income, net of service fees, was $20.9 million and $23.3 million for the quarters ended March 31, 2013 and 2012, respectively. The yield on our portfolio, excluding cash, was 11.16% and 13.51% for the quarters ended March 31, 2013 and 2012, respectively. Interest income decreased $2.4 million during the quarter ended March 31, 2013 primarily due to a net decrease in accretion of $10.3 million, partially offset by an increase of coupon of $8.0 million.

Interest Expense and the Cost of Funds

We had average interest bearing liabilities (including participation sold) of $33.1 million and $31.7 million for the quarters ended March 31, 2013 and 2012, respectively. Total interest expense, which includes the change in market value of the interest rate swap, totaled $383 thousand and $360 thousand for the quarters ended March 31, 2013 and 2012, respectively. Our average cost of funds, including the change in market value of the interest rate swap, was 4.63% and 4.55% for quarters ended March 31, 2013 and 2012, respectively. Our interest expense increased $23 thousand for the quarter ended March 31, 2013 as compared to the quarter ended March 31, 2012 primarily due to interest expense related to the participation sold.

Net Interest Income

Our net interest income, which equals interest income less interest expense and servicing fees, totaled $20.5 million and $22.9 million for the quarters ended March 31, 2013 and 2012, respectively. Our net interest income for the quarter ended March 31, 2013 decreased by $2.4 million primarily due to a net decrease in accretion of $10.3 million, partially offset by an increase of coupon income of $8.0 million as compared to the quarter ended March 31, 2012. Our net interest spread was 6.53% and 8.96% for the quarters ended March 31, 2013 and 2012, respectively. For the quarter ended March 31, 2013, the decrease in net interest spread is primarily due to the decrease in the overall yield of the portfolio and an increase in the average cost of funds for the quarter ended March 31, 2013 when compared to the quarter ended March 31, 2012.

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

Net Interest Income
(Ratios have been annualized, dollars in thousands)
					Yield on
	Average				Average			Average									Net
	Interest-Earning		Interest		Interest			Interest				Average			Net		Interest
	Assets		Earned on		Earning			Bearing		Interest		Cost			Interest		Rate
	Held (1)(2)		Assets (1)(2)(3)		Assets (1)(2)(3)			Liabilities (3)		Expense (3)		of Funds (3)			Income		Spread
For the quarter ended March 31, 2013	$	748,832	$	20,896		11.16	%	$	33,056	$	383		4.63	%	$	20,516		6.53	%
For the year ended December 31, 2012	$	705,607	$	88,013		12.47	%	$	26,137	$	1,138		4.35	%	$	86,893		8.12	%
For the quarter ended December 31, 2012	$	746,642	$	20,245		10.85	%	$	26,422	$	281		4.24	%	$	19,964		6.61	%
For the quarter ended September 30, 2012	$	747,049	$	26,816		14.36	%	$	19,150	$	187		3.92	%	$	26,629		10.44	%
For the quarter ended June 30, 2012	$	638,619	$	17,689		11.08	%	$	27,392	$	310		4.52	%	$	17,382		6.56	%
For the quarter ended March 31, 2012	$	689,210	$	23,270		13.51	%	$	31,656	$	360		4.55	%	$	22,916		8.96	%

(1) Excludes cash and cash equivalents.

(2) Includes non-recourse participation sold and corresponding related asset, interest income and expense.

(3) Net of servicing fees.

Rental Income

Our rental income for the quarters ended March 31, 2013 and 2012 was $832 thousand and $712 thousand, respectively. The increase in rental income during the quarter ended March 31, 2013 as compared to the quarter ended March 31, 2012 is due to a full quarter of rental income from the Nevada property and a new lease for one of the Arizona properties.

Management Fee and General and Administrative Expenses

We paid FIDAC management fees of $3.3 million and $3.5 million for the quarters ended March 31, 2013 and 2012, respectively. The decrease is due primarily to the decrease in equity (as defined) that is the basis of the management fee calculation for the quarter ended March 31, 2012.

General and administrative, or G&A, expenses were $4.4 million and $2.7 million for the quarters ended March 31, 2013 and 2012, respectively. The increase is primarily attributable to legal and consulting costs associated with the potential merger with Annaly.

Total management fee and G&A expenses as a percentage of average total assets, excluding provision for loan losses, depreciation and amortization, were 3.19% and 2.50% for the quarters ended March 31, 2013 and 2012, respectively. The increase is primarily attributable to legal and consulting costs associated with the potential merger with Annaly.

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.

Management Fees and G&A Expenses 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/Average			Expenses/Average
	Expenses		Total Assets			Equity
For the quarter ended March 31, 2013	$	7,707		3.19	%		3.41	%
For the year ended December 31, 2012	$	20,435		2.10	%		2.23	%
For the quarter ended December 31, 2012	$	4,875		2.01	%		2.14	%
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	%

Net Income and Return on Average Equity

Our net income was $13.4 million for the quarter ended March 31, 2013 as compared to net income of $16.1 million for the quarter ended March 31, 2012. The decrease in net income for the quarter ended March 31, 2013 is primarily due to the net decrease in accretion income of $10.3 million as well as an increase in G&A expenses of $1.7 million relating to the potential merger with Annaly, partially offset by an increase of coupon of $8.0 million due to an increase in average interest-earning assets as compared to the quarter ended March 31, 2012. During the quarter ended March 31, 2012 we recognized a net $2.8 million provision for loan losses. No provision for loan losses was recognized for the quarter ended March 31, 2013. During the quarter ended March 31, 2013 total income (loss) from discontinued operations decreased by $1.4 million primarily due to a decrease of income from discontinued operations, net of tax expense, of $2.0 million as compared to the quarter ended March 31, 2012. During the quarter ended March 31, 2013, the Company recognized an impairment charge of $266 thousand as a component of discontinued operations with no comparable amounts for the quarter ended March 31, 2012. The net loss from discontinued operations is partially offset by a gain on sale of a property held for sale of $886 thousand. The table below summarizes our net interest income, fee income, rental income, total expenses, realized gains (losses), and net income from discontinued operations each as a percentage of average equity for the periods presented. The table also highlights the return on average equity for the periods presented.

Components of Return on Average Equity
(Ratios have been annualized)
																Net Income on
	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 March 31, 2013		9.07	%		0.00	%		0.37	%		(3.58	%)		0.00	%		0.05	%		5.92	%
For the year ended December 31, 2012		9.49	%		0.04	%		0.34	%		(2.71	%)		(0.06	%)		0.65	%		7.75	%
For the quarter ended December 31, 2012		8.76	%		0.00	%		0.36	%		(2.31	%)		0.00	%		1.04	%		7.85	%
For the quarter ended September 30, 2012		11.57	%		0.00	%		0.35	%		(2.24	%)		0.00	%		0.15	%		9.83	%
For the quarter ended June 30, 2012		7.54	%		0.00	%		0.35	%		(2.18	%)		(0.23	%)		0.75	%		6.23	%
For the quarter ended March 31, 2012		9.91	%		0.15	%		0.31	%		(4.06	%)		0.00	%		0.66	%		6.97	%

(1) Includes provision for loan loss, depreciation and amortization.

(2) Includes net income or loss, gain on sale and impairment charges related to discontinued operations.

Discontinued Operations

We recorded net income of $121 thousand and $1.5 million from discontinued operations during the quarters ended March 31, 2013 and 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. The decrease in net income from discontinued operations during the quarter ended March 31, 2013 compared to the quarter ended March 31, 2012 is primarily attributable to the sale of four hotels subsequent to March 31, 2012, and the seasonal nature of the operating performance of the hotels remaining in the portfolio at March 31, 2013. Net income from discontinued operations is recorded net of tax expense of $255 thousand and $295 thousand during the quarters ended March 31, 2013 and 2012, respectively. We recorded a pre-tax gain on sale from discontinued operations of $886 thousand during the quarter ended March 31, 2013. Additionally, we incurred a $266 thousand impairment charge on real estate held for sale during the quarter ended March 31, 2013. We had no sales from discontinued operations during the quarter ended March 31, 2012.

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 respective 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 financings 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 portions 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 may 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 may have the sole discretion to determine the value of the Agency RMBS securing our repurchase agreements. In instances where we agree 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 March 31, 2013, 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.

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 commercial real estate loans, cash flow from the sale of securities, rental income from our net lease investments, proceeds from sales of discontinued operations 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. 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 may be subject to obtaining additional debt financing and equity capital. Subject to 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 financings 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 $164.5 million and $123.5 million at March 31, 2013 and December 31, 2012, respectively. The increase in cash and cash equivalents is primarily due to the repayment of loans.

Our operating activities provided net cash of approximately $11.7 million and $5.8 million for the quarters ended March 31, 2013 and 2012, respectively. The increase in net cash provided by operating activities is primarily due to an increase in coupon interest income.

Our investing activities provided net cash of $53.8 million and $73.2 million for the quarters ended March 31, 2013 and 2012, respectively. The decrease in net cash provided by investing activities is primarily attributable to a decrease in principal payments on loans.

Our financing activities for the quarter ended March 31, 2013 resulted in the net use of cash of $24.6 million, primarily attributable to $24.5 million paid in dividends to our common shareholders. Our financing activities for the quarter ended March 31, 2012 resulted in the net use of cash of $24.3 million, primarily attributable to $26.8 million paid in dividends to our common shareholders.

At March 31, 2013 and 2012, we had outstanding financing agreements of $19.2 million, and had remaining maturities of approximately 4 years.

We are not required to maintain any specific debt-to-equity ratio. We believe the appropriate leverage for the particular assets we are financing depends on the credit quality and risk of those assets. At March 31, 2013 our total non-recourse debt (excluding non-recourse participation sold) was approximately $19.2 million which represented a debt-to-equity ratio of approximately 0.02:1. At December 31, 2012 our total debt was approximately $19.2 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 March 31, 2013 and December 31, 2012.

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.

On January 30, 2013, we and our Manager entered into an amendment to the management agreement pursuant to which, our Manager has agreed to, among other things, in good faith facilitate and assist the Company in its efforts to actively seek and solicit acquisition proposals during the Transaction Solicitation Period (as defined in the Merger Agreement) and, following the conclusion of the Transaction Solicitation Period, in good faith facilitate and assist our discussions, negotiations, providing of information and any other permissible action with respect to possible acquisition proposals under the terms of the Merger Agreement. The amendment also shortens the notice provision for our termination of the management agreement from 180 days to 60 days’ notice at any time during the first six months following the acquisition by a third party of a majority of our stock or assets.

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.

Agreement and Plan of Merger

On January 30, 2013, the Company entered into the Merger Agreement, among the Company, Annaly and CXS Acquisition Corporation (a wholly-owned subsidiary of Annaly) (or Acquisition), pursuant to which, among other things, Acquisition would commence a tender offer (or the Offer) to purchase all of the outstanding shares of the Company’s common stock, par value $0.01 per share (or the Shares), that Acquisition or Annaly did not own at a price per share of $13.05206, which reflects a price of $13.00 in cash, plus a cash payment to reflect a pro-rated quarterly dividend for the quarter in which the Offer was consummated, subject to the terms and conditions set forth in the Merger Agreement.

Pursuant to the terms of the Merger Agreement, Annaly commenced the Offer on March 18, 2013. The Offer expired at 5:00 p.m., New York City Time on April 16, 2013. The depository for the Offer has advised Annaly and Acquisition that, as of such time, an aggregate of approximately 55,225,336 Shares were tendered into, and not withdrawn from, the Offer (including 2,318,138 Shares tendered by notices of guaranteed delivery) representing approximately 82.3% of the outstanding Shares not previously held by Annaly. Acquisition accepted for payment of all Shares that were validly tendered and not properly withdrawn, and payment was made promptly, in accordance with the terms of the Offer. The depository subsequently informed the Company that only 2,153,224 of the 2,318,138 Shares tendered by notices of guaranteed delivery were actually delivered. This resulted in a total number of 55,060,422 Shares being tendered into, and not withdrawn from, the Offer representing approximately 82.1% of the outstanding Shares not previously held by Annaly.

As of May 6, 2013, Annaly, through Acquisition, owns approximately 84.3% of the Company’s outstanding shares.

Clearing and Underwriting Fees

We use RCap Securities, Inc., a wholly-owned subsidiary of Annaly, or RCAP, to clear trades for us and RCap receives customary fees and charges in connection with the provision of such services. For the quarters ended March 31, 2013 and 2012 we paid RCap approximately $9 thousand and $8 thousand, respectively, for its services.

Contractual Obligations and Commitments

As of March 31, 2013 we financed a portion of our real estate assets with non-recourse loans. The table below for a summary of our contractual obligations at March 31, 2013 and December 31, 2012.

	March 31, 2013

	Within One Year		One to Three Years		Three to Five Years		Greater Than Five Years		Total
Contractual Obligations	(dollars in thousands)
Loan	$	-	$	510	$	18,640	$	-	$	19,150
Interest expense on loan		670		1,329		553		-		2,552
Total	$	670	$	1,839	$	19,193	$	-	$	21,702

	December 31, 2012

	Within One Year		One to Three Years		Three to Five Years		Greater Than Five Years		Total
Contractual Obligations	(dollars in thousands)
Loan	$	-	$	411	$	18,739	$	-	$	19,150
Interest expense on loan		670		1,333		717		-		2,720
Total	$	670	$	1,744	$	19,456	$	-	$	21,870

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 certain performance hurdles were met. During the year ended December 31, 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.

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 outstanding indebtedness.

During the quarter ended March 31, 2013, we declared dividends to common shareholders totaling $19.2 million or $0.25 per share, which were paid on April 26, 2013. During the quarter ended March 31, 2012, we declared dividends to common shareholders totaling $20.7 million or $0.27 per share, which were paid on April 26, 2012.

Capital Expenditures

At March 31, 2013 and December 31, 2012, we had no material commitments for capital expenditures.

Inflation

Virtually all of our assets and liabilities are 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 Internal Revenue Code (the Code) as of March 31, 2013 and December 31, 2012. 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 March 31, 2013 and the year ended December 31, 2012 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 March 31, 2013 and December 31, 2012, 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 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.

We determined that as of March 31, 2013 and December 31, 2012, we were in compliance with the exemption from registration provided by Section 3(c)(5)(C) of the 1940 Act as interpreted by the staff of the SEC.

As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the U.S. Commodity Futures Trading Commission (or CFTC) gained jurisdiction over the regulation of interest rate swaps. The CFTC has asserted that this causes the operators of mortgage real estate investment trusts that use swaps as part of their business model to fall within the statutory definition of Commodity Pool Operator (or CPO), and, absent relief from the Division or the Commission, to register as CPOs. On December 7, 2012, as a result of numerous requests for no-action relief from the CPO registration requirement for operators of mortgage real estate investment trusts, the Division of Swap Dealer and Intermediary Oversight of the CFTC issued no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” that permits a CPO to receive relief by filing a claim to perfect the use of the relief. A claim submitted by a CPO will be effective upon filing, so long as the claim is materially complete. The conditions that must be met to claim the relief are that the mortgage real estate investment trust must:

●

Limit the initial margin and premiums required to establish its commodity interest positions to no more than 5 percent of the fair market value of the mortgage real estate investment trust’s total assets;

●

Limit the net income derived annually from its commodity interest positions that are not qualifying hedging transactions to less than five percent of the mortgage real estate investment trust’s gross income;

●

Ensure that interests in the mortgage real estate investment trust are not marketed to the public as or in a commodity pool or otherwise as or in a vehicle for trading in the commodity futures, commodity options, or swaps markets; and

●

Either:

●

identify itself as a “mortgage REIT” in Item G of its last U.S. income tax return on Form 1120-REIT; or

●

if it has not yet filed its first U.S. income tax return on Form 1120-REIT, but has disclosed to its shareholders that it intends to identify itself as a “mortgage REIT” in its first U.S. income tax return on Form 1120-REIT.

While we disagree that the CFTC’s position that mortgage real estate investment trusts that use swaps as part of their business model fall within the statutory definition of a CPO, we have submitted a claim for the relief set forth in the no-action relief entitled “No-Action Relief from the Commodity Pool Operator Registration Requirement for Commodity Pool Operators of Certain Pooled Investment Vehicles Organized as Mortgage Real Estate Investment Trusts” and believe we meet the criteria for such relief set forth therein.

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 risk and market value risk. While we do not seek to avoid risk completely, we believe 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 where we hold a subordinate position. 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 likelihood that we may not recover our cost basis. The criteria used to assess 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 also consider other factors we deem important. We review market pricing to determine the ability to refinance the asset. We also 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.

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. 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 and 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.

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 could adversely affect 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 March 31, 2013 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)		1.91	%
-50 Basis Points		0.00	%	(1)		1.27	%
-25 Basis Points		0.00	%	(1)		0.63	%
Base Interest Rate		-				-
+25 Basis Points		0.00	%			(0.63	%)
+50 Basis Points		0.02	%			(1.27	%)
+75 Basis Points		0.34	%			(1.90	%)

(1) Reflects consideration of floors on variable rate loans.

Prepayment Risk

As we receive prepayments of principal on our assets, premiums paid or purchase discounts on such assets will be amortized or accreted to 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:

●

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, swaps, options, caps, and floors 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 March 31, 2013. 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 in the following table could vary substantially based on actual prepayment experience.

	Within 3			3-12			1 Year to			Greater than
	Months			Months			3 Years			3 Years			Total

Rate sensitive assets, principal balance	$	213,816		$	33,473		$	146,361		$	333,584		$	727,234
Cash and cash equivalents		164,472			-			-			-			164,472
Total rate sensitive assets		378,288			33,473			146,361			333,584			891,706

Rate sensitive liabilities		2,550			-			-			16,600			19,150

Interest rate sensitivity gap	$	375,738		$	33,473		$	146,361		$	316,984		$	872,556

Cumulative rate sensitivity gap	$	375,738		$	409,211		$	555,572		$	872,556

Cumulative interest rate sensitivity
gap as a percentage of total rate
sensitive assets		42.14	%		45.89	%		62.30	%		97.85	%

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."

Item 4. CONTROLS AND PROCEDURES

The Company’s management, including its Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”) reviewed and evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of 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 the information regarding the Company and its subsidiaries is accumulated and communicated to our management, including our CEO and CFO by our employees, 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 controls over financial reporting that occurred during the quarter ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

We are not party to any material litigation or legal proceedings, or to the best of our knowledge, any threatened litigation or legal proceedings, which, in our opinion, individually or in the aggregate, would have a material effect on our results of operations or financial condition.

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.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Pursuant to the Merger Agreement, the Company is restricted from declaring or paying any dividends to its stockholders, other than regular quarterly dividends paid by the Company consistent with its past practice of paying quarterly dividends based upon its estimated REIT taxable income for the quarter.

Item 6. EXHIBITS

EXHIBIT INDEX

Exhibit Number	Description

2.1	Agreement and Plan of Merger, dated as of January 30, 2013, by and among CreXus Investment Corp., Annaly Capital Management, Inc. and CXS Acquisition Corporation (filed with the Securities and Exchange Commission as Exhibit 2.1 to the Company’s Form 8-K on January 31, 2013 and incorporated herein by reference).
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 Form 10-Q (filed with the Securities and Exchange Commission 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 Jack DeCicco, 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 Jack DeCicco, 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 March 31, 2013 (Unaudited) and December 31, 2012 (Derived from the audited consolidated statement of financial condition at December 31, 2012); (ii) Consolidated Statements of Comprehensive Income (Unaudited) for the quarters ended March 31, 2013 and 2012; (iii) Consolidated Statement of Stockholders' Equity (Unaudited) for the quarters ended March 31, 2013 and 2012; (iv) Consolidated Statements of Cash Flows (Unaudited) for the quarters ended March 31,2013and 2012; and (v) Notes to Consolidated Financial Statements (Unaudited) ) for the quarters ended March 31,2013and 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.

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, in the city of New York, State of New York.

	CREXUS INVESTMENT CORP.


	By:	/s/ Kevin Riordan
		Kevin Riordan
		Chief Executive Officer, and President
		May 6, 2013



	By:	/s/ Jack DeCicco
		Jack DeCicco
		Chief Financial Officer and Principal Accounting Officer
		May 6, 2013