We are a specialty finance company that invests primarily in residential mortgage loans and mortgage-related assets. Our objective is to provide attractive risk-adjusted returns to our investors over the long-term, principally through dividends and secondarily through capital appreciation. We intend to achieve this objective largely by investing in distressed mortgage assets and acquiring, pooling and selling newly originated prime credit quality residential mortgage loans ("correspondent lending").

We invest in distressed mortgage loans through direct acquisitions of mortgage loan portfolios from institutions such as banks and mortgage companies. A substantial portion of the nonperforming loans we have purchased has been acquired from or through one or more subsidiaries of Citigroup, Inc.

We seek to maximize the value of the distressed mortgage loans that we acquire using means that are appropriate for the particular loan, including both proprietary and nonproprietary loan modification programs (such as the U.S. Departments of the Treasury and Housing and Urban Development's Home Affordable Modification Program ("HAMP")) special servicing and other initiatives focused on avoiding foreclosure, when possible. When we are unable to effect a cure for a mortgage delinquency, our objective is to effect timely acquisition and/or liquidation of the property securing the loan through the use, in part, of short sales and deed-in-lieu of foreclosure programs. During the quarter and nine months ended September 30, 2012, we purchased $150.8 million and $411.4 million, respectively, of distressed mortgage loans. During the quarter and nine months ended September 30, 2012, we received proceeds from liquidation, payoffs and sales from our portfolio of distressed mortgage loans and REO totaling $82.8 million and $256.7 million, respectively.

Changes in the mortgage market have significantly reduced the outlets for sales of newly originated mortgage loans by mortgage lenders who have traditionally sold their loans to larger mortgage companies and banks who, in turn, sold those loans to Agencies and other investors or into securitizations. We believe that these changes are due in part to banks' anticipation of regulatory changes to loan and securitization-related capital requirements, along with a focus on retail lending; and that the changes provide us with the opportunity to act as a link between loan originators and the Agency and securitization markets.

During the quarter and nine months ended September 30, 2012, we purchased loans with fair values totaling $6.6 billion and $12.0 billion, respectively, in furtherance of our correspondent lending business. To the extent that we purchase loans that are insured by the U.S. Department of Housing and Urban Development's Federal Housing Administration ("FHA") insured or guaranteed by the Veterans Administration, we and PLS have agreed that PLS will fulfill and purchase such loans, as PLS is a GNMA approved issuer and servicer. This arrangement has enabled us to compete with other correspondent lenders that purchase both government and conventional loans. We receive a sourcing fee from PLS of three basis points on the unpaid principal balance of each loan that we sell to PLS under such arrangement, and earn interest income on the loan for the time period we hold the loan prior to the sale to PLS. We held an inventory of mortgage loans acquired for sale totaling $847.6 million at September 30, 2012, including mortgage loans pending sale to PLS totaling $194.1 million. We received sourcing fees totaling $747 thousand and $1.4 million relating to $2.5 billion and $4.8 billion of loans we sold to PLS for the quarter and nine months ended September 30, 2012. We supplement these activities through participation in other mortgage-related activities, which are in various states of analysis, planning or implementation including:

• Acquisition of REIT-eligible MBS. We purchased zero and $112.2 million of MBS during the quarter and nine months ended September 30, 2012, respectively. During the quarter ended September 30, 2012, we sold all of our holdings of MBS.

• Acquisition of MSRs from liquidating and other institutions. We believe that current market conditions may have adversely affected the financial condition and operations of certain owners of mortgage assets. Further, regulatory and capital issues may have contributed to their decision to reduce their portfolio of MSRs. We believe that MSR investments may allow us to earn attractive current returns and to leverage the loan servicing capabilities and efficiencies of PLS to improve the assets' value. We would also seek to leverage the loan origination capabilities of PLS provided we are able to structure

We also intend to continue to retain the MSRs that we receive as a portion of the proceeds from our sale or securitization of mortgage loans through our correspondent lending operation. We received MSRs as proceeds on sale of mortgage loans with fair values totaling $36.8 million and $66.6 million during the quarter and nine months ended September 30, 2012 and held MSRs with carrying values of $65.2 million as of September 30, 2012.

• Providing inventory financing of mortgage loans for mortgage lenders. We believe this activity may result in attractive investment assets for us and supplement and make our correspondent lending business more attractive to lenders from which we acquire newly originated loans. During the quarter ended September 30, 2012, we obtained a re-warehouse facility with a maximum lending commitment of $50 million to facilitate the financing of this activity. The re-warehouse facility is committed to September 27, 2013.

• To the extent that we transfer correspondent lending loans into private label securitizations in the future, we may retain a portion of the securities created in the securitization transaction.

We are externally managed by PCM, an investment adviser that specializes in, and focuses on, residential mortgage loans. Most of our mortgage loan portfolio is serviced by PLS, an affiliate of PCM.

We conduct substantially all of our operations, and make substantially all of our investments, through our Operating Partnership and its subsidiaries. We are the sole limited partner and one of our subsidiaries is the sole general partner of our Operating Partnership.

We believe that we qualify to be taxed as a REIT. We believe that we will not be subject to federal income tax on that portion of our income that is distributed to shareholders as long as we meet certain asset, income and share ownership tests. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, our profits will be subject to income taxes and we may be precluded from qualifying as a REIT for the four tax years following the year we lose our REIT qualification. A portion of our activities, including our correspondent lending business, is conducted in a taxable REIT subsidiary ("TRS"), which is subject to corporate federal and state income taxes. Accordingly, we have made a provision for income taxes with respect to the operations of our TRS. In the quarter ended September 30, 2012, we revoked the election to treat as a TRS our wholly-owned subsidiary that is the sole general partner of our operating partnership. A provision for income taxes has been made for the period for which TRS treatment had been elected for this subsidiary. We expect that the effective rate for the provision for income taxes may be volatile in future periods. Our goal is to manage the business to take full advantage of the tax benefits afforded to us as a REIT.

Observations on Current Market Opportunities

The U.S. economy continues its pattern of modest growth as reflected in recent economic data. During the third quarter of 2012, real U.S. gross domestic product expanded at an annual rate of 2.0% compared to a revised 1.3% annual rate for both the second quarter of 2012 and the third quarter of 2011. Modest economic growth and pressure on state and federal government spending continued to affect unemployment rates during 2012. The national unemployment rate was 7.8% at September 30, 2012, the first time the rate was below 8% since January 2009 and compares to a revised seasonally adjusted rate of 9.0% at September 30, 2011 and 8.5% at December 31, 2011. Declining unemployment is partially reflective of a declining workforce labor participation rate. Delinquency rates on single family residential mortgage loans linger at historically high rates. During the second quarter of 2012, delinquency rates were 10.6%, a slight reduction from the cyclical high of 11.2% during the first quarter of 2010.

Residential real estate activity appears to be modestly improving. The seasonally adjusted annual rate of existing home sales for September 2012 was 11.0% higher than for September 2011 and the national median existing home price for all housing types was $183,900, an 11.3% increase from September 2011. On a national level, foreclosure filings during the third quarter of 2012 decreased 5% as compared to the second quarter of 2012 and 13% as compared to the third quarter of 2011, representing the ninth consecutive quarter with an annual decrease in foreclosure activity. A previously expected increase in foreclosure activity at the national level as lenders resolve their operational issues relating to the foreclosure of delinquent loans has not yet materialized, however it is anticipated that foreclosure activity within select markets may increase during the remainder of 2012 and beyond.

Thirty-year fixed rate mortgage interest rates ranged from a high of 3.66% to a low of 3.40% during the third quarter of 2012 with the low of 3.40% representing an all-time record low for the thirty-year fixed rate mortgage (Source: the Federal Home Loan Mortgage Corporation's Weekly Primary Mortgage Market Survey). During the first nine months of 2012 mortgage interest rates have ranged from a high of 4.08% to the all-time record low of 3.40%. Mortgage interest rates during the third quarter were relatively unchanged until the Federal Reserve began its purchases of mortgage securities pursuant to a third round of quantitative easing. During the first nine months of 2011, mortgage interest rates ranged from a high of 5.05% to a low of 4.01%.

The Manager continues to see substantial volumes of distressed residential mortgage loan sales (sales of loan pools that consist of either nonperforming loans, troubled but performing loans or a combination thereof) offered for sale by a limited number of sellers. During the third quarter of 2012, our Manager reviewed 23 mortgage loan pools with unpaid principal balances totaling approximately $3.8 billion. This compares to our Manager's review of 20 mortgage loan pools with unpaid principal balances totaling approximately $3.6 billion during the third quarter of 2011. We acquired distressed mortgage loans with fair values totaling $150.5 million and $288.9 million during the quarter and nine months ended September 30, 2012, respectively.

We believe that the shifting investment and operational priorities of banks and other traditional mortgage lenders have created additional opportunities for our business. Under current market conditions, these opportunities include the purchase from mortgage lenders of newly originated mortgage loans that are eligible for sale to an Agency. These opportunities also include the purchase of newly originated mortgage loans that can be resold in the non-Agency whole loan market or securitized in the private label market as well as providing inventory financing to originators of such loans. During the quarter and nine months ended September 30, 2012, we acquired approximately $6.6 billion and $12.0 billion, respectively, in fair value of newly originated mortgage loans and received proceeds of approximately $6.3 billion and $11.4 billion, respectively, on the sale of loans.

Results of Operations

The following is a summary of our key performance measures for the periods
presented:



                                          Quarter ended September 30,               Nine months ended September 30,
                                           2012                  2011                  2012                   2011
                                                          (in thousands, except per share amounts)
Net investment income                $         99,196       $       41,985      $          210,251       $       89,491
Pre-tax income by segment(1):
Investment                           $         21,542       $           -       $           61,774       $           -
Correspondent lending                $         37,427       $           -       $           59,745       $           -
Net income (loss)                    $         40,384       $       20,528      $           89,011       $       44,790
Earnings (loss) per share:
Basic                                $           0.81       $         0.73      $             2.29       $         1.72
Diluted                              $           0.81       $         0.73      $             2.29       $         1.72
Dividends per share:
Declared                             $           0.55       $         0.50      $             1.65       $         0.92
Paid                                 $           0.55       $         0.50      $             1.65       $         1.34

Cash Flows:
Investment activities:
Distressed mortgage loans and REO
Purchases                            $        150,778       $      264,749      $          411,368       $      625,152
Proceeds from liquidation
activities                           $         82,783       $       69,773      $          256,663       $      156,815
MBS
Purchases                            $             -        $       22,179      $          112,211       $       22,179
Proceeds from repayments and
sales                                $        167,910       $       17,492      $          189,167       $       55,002

Correspondent lending:
Purchases of mortgage loans for
sale                                 $      6,597,138       $      220,040      $       11,967,678       $      294,410
Proceeds from sales of mortgage
loans for sale:
Cash
Sales to nonaffilate investors       $      3,573,762       $       53,221      $        6,254,411       $       72,796
Sales of government-insured and
guaranteed loans to PLS                     2,650,097              144,351               5,108,340              184,264

                                            6,223,859              197,572              11,362,751              257,060
MSRs                                           36,760                  466                  66,649                  643

                                     $      6,260,619       $      198,038      $       11,429,400       $      257,703

Share price:
High                                 $          23.52       $        17.45      $            23.52       $        19.31
Low                                  $          19.72       $        15.34      $            16.69       $        15.34
At period end                        $          23.37       $        15.90      $            23.37       $        15.90

(1) Before the third quarter of 2011, the Company's activities were almost exclusively within the investment activities segment.

During the quarter and nine months ended September 30, 2012, we recorded net income of $40.4 million and $89.0 million, or $0.81 and $2.29 per diluted share, respectively. Our net income for the quarter and nine months ended September 30, 2012 reflects net gains on our investments in financial instruments totaling $75.9 million and $146.8 million (comprised of net gain on investments and net gain on mortgage loans acquired for sale), including $22.3 million and $53.0 million of valuation gains on MBS and mortgage loans excluding mortgage loans acquired for sale, supplemented by $19.7 million and $52.2 million of interest income, respectively. During the quarter and nine months ended September 30, 2012, we purchased $6.6 billion and $12.0

billion, respectively, in fair value of newly originated mortgage loans. We recognized gains on such loans totaling approximately $49.8 million and $81.2 million, respectively. At September 30, 2012, we held mortgage loans acquired for sale with fair values totaling $847.6 million, including $194.1 million pending sale to PLS. Growth in our earnings reflect growth in the Company's assets from $1.2 billion at September 30, 2011 to $2.3 billion at September 30, 2012. We achieved this growth in assets through a combination of issuance of additional common shares of beneficial interest (common shares) and by leveraging such issuances with additional borrowing capacity.

During the quarter and nine months ended September 30, 2011, we recorded net income of $20.5 million and $44.8 million, or $0.73 and $1.72 per diluted share, respectively. Our net income for the quarter and nine months ended September 30, 2011 reflected net gains on our investments in financial instruments totaling $31.5 million and $63.5 million (comprised of net gain on investments and net gain on mortgage loans acquired for sale), including $23.0 million and $48.8 million of valuation gains on MBS and mortgage loans excluding mortgage loans acquired for sale, supplemented by $9.8 million and $24.0 million of interest income, respectively. During the quarter and nine months ended September 30, 2011, we purchased $220.0 million and $294.4 million, respectively, in fair value of newly originated mortgage loans. We recognized gains on such loans totaling approximately $84,000 and $207,000, respectively. At September 30, 2011, we held mortgage loans acquired for sale with fair values totaling $40.9 million.

Net Investment Income

During the quarter and nine months ended September 30, 2012, we recorded net investment income of $99.2 million and $210.3 million, respectively, comprised primarily of net gains on investments in financial instruments of $75.9 million and $146.8 million supplemented by $19.7 million and $52.2 million of interest income and $1.3 million and $7.6 million from results of REO, partially offset by negative net servicing fees of $511,000 and $1.2 million, respectively. This compares to net investment income of $42.0 million and $89.5 million recognized during the quarter and nine months ended September 30, 2011, comprised primarily of $31.5 million and $63.5 million of net gains on investments in financial instruments, supplemented by $9.8 million and $24.0 million of interest income, $352,000 and $1.5 million of gains from results of REO and net servicing fees of $14,000 and $17,000, respectively.

The growth in net investment income reflects the growth in the distressed loan portfolio, REOs and correspondent lending activities.

Net investment income on financial instruments is summarized below for the periods presented:

                                                                                 Quarter ended September 30, 2012

                                      Net gain                 Interest income/expense               Total               Annualized %
                                      (loss) on                      Discount/         Total       revenue/         Average        Interest           Total
                                     investments        Coupon        fees(1)        interest       expense         balance       yield/cost        return(2)
                                                                                      (dollars in thousands)
Assets:
Short-term investments              $          -       $     13     $        -       $      13     $      13      $    59,589            0.09 %           0.09 %
Mortgage-backed securities:
Fannie Mae 30-year fixed(3)                  (422 )         556             (92 )          464            42           62,307            2.92 %           0.27 %
Non-Agency subprime                          (159 )          15              -              15          (144 )          8,794            0.63 %          (6.43 )%
Non-Agency Alt-A                               90            18              -              18           108            1,100            6.11 %          38.06 %
Non-Agency prime jumbo                         40             5              -               5            45              657            2.76 %          25.92 %

Total mortgage-backed securities             (451 )         594             (92 )          502            51           72,858            2.69 %           0.27 %

Mortgage loans:
Investment portfolio:
At fair value                              26,407        12,889              -          12,889        39,296          883,732            5.71 %          17.40 %
Under forward purchase agreements
at fair value                                 105           146              -             146           251            8,996            6.38 %          10.96 %

Total investment portfolio                 26,512        13,035              -          13,035        39,547          892,728            5.71 %          17.33 %
Correspondent lending:
Acquired for sale at fair value            49,793         6,144              -           6,144        55,937          526,047            4.57 %          41.61 %

Total mortgage loans                       76,305        19,179              -          19,179        95,484        1,418,775            5.29 %          26.34 %

Other interest                                 -             36              -              36            36

                                    $      75,854      $ 19,822     $       (92 )    $  19,730     $  95,584      $ 1,551,222            4.98 %          24.11 %

Liabilities:
Assets sold under agreements to
repurchase:
Securities                          $          -       $     99     $        -       $      99     $      99      $    75,787            0.51 %
Mortgage loans at fair value                   -          3,362             439          3,801         3,801          333,216            4.46 %
Mortgage loans acquired for sale
at fair value                                  -          2,860           1,088          3,948         3,948          462,137            3.34 %
Real estate acquired in
settlement of loans                            -            168             125            293           293           15,461            7.41 %

$ - $ 6,589 $ 1,693 $ 8,282 $ 8,282 $ 896,388 3.62 %

(1) Amounts in this column represent accrual of unearned discounts and amortization of purchase premiums for assets and facility commitment fees for liabilities.

(2) Total return represents the sum of the interest yield and the net gain (loss) on the respective investments and does not take into account expenses associated with managing the asset.

(3) Includes the fair value losses recognized on an MBS swaption purchased to reduce the risk of interest rate fluctuations with respect to indebtedness incurred to acquire such assets.

                                                                                 Quarter ended September 30, 2011

                                   Net gain                    Interest income/expense                  Total                                Annualized %
                                   (loss) on                          Discount/         Total         revenue/         Average        Interest            Total
                                  investments         Coupon           fees(1)         interest        expense         balance       yield/cost         return(2)
                                                                                      (dollars in thousands)
Assets:
Short-term investments           $          -        $      24       $        -       $       24      $      24       $  39,472             0.23 %            0.23 %
Mortgage-backed securities:
Non-Agency subprime                       (612 )            70               262             332           (280 )        58,468             2.23 %           (1.87 )%
Non-Agency Alt-A                          (135 )           150               116             266            131          10,668             9.73 %            4.78 %
Non-Agency prime jumbo                     (44 )            46                 7              53              9           6,963             2.96 %            0.47 %

Total mortgage-backed
securities                                (791 )           266               385             651           (140 )        76,099             3.35 %           (0.73 )%

Mortgage loans:
Investment portfolio:
At fair value                           32,311           8,745                -            8,745         41,056         744,488             4.60 %           21.58 %
Correspondent lending:
Acquired for sale at fair at
fair value                                  84             419                -              419            503          30,900             5.30 %            6.37 %

Total mortgage loans                    32,395           9,164                -            9,164         41,559         775,388             4.62 %           20.97 %

                                 $      31,604       $   9,454       $       385      $    9,839      $  41,443       $ 890,959             4.32 %           18.20 %

Liabilities:
Assets sold under agreements
to repurchase:
Securities                       $          -        $     161       $        -       $      161      $     161       $  65,364             0.96 %
Mortgage loans at fair value                -            2,520               211           2,731          2,731         248,651             4.30 %
Mortgage loans acquired for
sale at fair value                          -              187               187             374            374          27,701             5.30 %
Real estate acquired in
settlement of loans                         -              154               125             279            279          12,663             8.63 %
Borrowings under forward
purchase agreements                         -            1,680                -            1,680          1,680         146,708             4.48 %

                                 $          -        $   4,702       $       523      $    5,225      $   5,225       $ 501,087             4.08 %

(1) Amounts in this column represent accrual of unearned discounts for assets and facility commitment fees for liabilities.

(2) Total return represents the sum of the interest yield and the net gain (loss) on the respective investments and does not take into account expenses associated with managing the asset.