Edgar Filing: Ellington Financial LLC

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-34569

Ellington Financial LLC

(Exact Name of Registrant as Specified in Its Charter)

Delaware

26-0489289

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

53 Forest Avenue, Old Greenwich, Connecticut 06870

(Address of Principal Executive Office) (Zip Code)

(203) 698-1200

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

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

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

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


Class		Outstanding at November 9, 2011
Common Shares Representing Limited Liability Company Interests, no par value		16,491,131

ELLINGTON FINANCIAL LLC

FORM 10-Q


PART I. Financial Information			2
Item 1. Consolidated Financial Statements (unaudited)			2
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			43
Item 3. Quantitative and Qualitative Disclosures about Market Risk			67
Item 4. Controls and Procedures			69
PART II. OTHER INFORMATION			69
Item 1. Legal Proceedings			69
Item 1A. Risk Factors			70
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			71

PART I. FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements (unaudited)

ELLINGTON FINANCIAL LLC

CONSOLIDATED STATEMENT OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY

(UNAUDITED)


	September 30, 2011		December 31, 2010
(In thousands except share amounts)	*Expressed in U.S. Dollars*
ASSETS
Cash and cash equivalents	$	41,611	$	35,791

Investments, financial derivatives and repurchase agreements:
Investments at value (Cost – $1,310,625 and $1,232,484)		1,302,351		1,246,067
Financial derivatives – assets (Cost – $119,307 and $208,958)		111,405		201,335
Repurchase agreements (Cost – $18,035 and $25,684)		18,035		25,684

Total investments, financial derivatives and repurchase agreements		1,431,791		1,473,086
Deposits with dealers held as collateral		36,669		20,394
Receivable for securities sold		890,429		799,142
Interest and principal receivable		7,598		5,909
Other assets		234		—

Total Assets	$	2,408,332	$	2,334,322


LIABILITIES
Investments and financial derivatives:
Investments sold short at value (Proceeds – $562,607 and $775,782)	$	562,670	$	775,145
Financial derivatives – liabilities (Net Proceeds – $13,825 and $17,718)		34,988		21,030

Total investments and financial derivatives		597,658		796,175
Reverse repurchase agreements		884,216		777,760
Due to brokers on margin accounts		92,064		166,409
Payable for securities purchased		453,464		184,013
Accounts payable and accrued expenses		1,888		2,485
Accrued base management fee		1,418		1,525
Accrued incentive fees		—		1,422
Interest and dividends payable		950		861

Total Liabilities		2,031,658		1,930,650

SHAREHOLDERS’ EQUITY		376,674		403,672

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	2,408,332	$	2,334,322

ANALYSIS OF SHAREHOLDERS’ EQUITY:
Common shares, no par value, 100,000,000 shares authorized;
(16,489,881 and 16,498,342 shares issued and outstanding)	$	367,804	$	394,918
Additional paid-in capital – LTIP units		8,870		8,754

Total Shareholders’ Equity	$	376,674	$	403,672

PER SHARE INFORMATION:
Common shares, no par value	$	22.84	$	24.47

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT SEPTEMBER 30, 2011

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate	Maturity	Value
(In thousands)					Expressed in U.S. Dollars
	Long Investments (345.75%) (a) (b) (n)

	Mortgage-Backed Securities (344.59%)

	Agency Securities (235.44%)

	Fixed Rate Agency Securities (221.40%)

	Principal and Interest - Fixed Rate Agency Securities (205.94%)

$	85,751	Federal Home Loan Mortgage Corporation Pool	4.50%	10/41	$	91,244
	71,809	Government National Mortgage Association Pool	5.00%	4/40		79,271
	35,326	Federal National Mortgage Association Pool	5.00%	4/41		38,257
	33,422	Federal National Mortgage Association Pool	5.00%	5/41		36,102
	25,985	Federal Home Loan Mortgage Corporation Pool	4.00%	11/40		27,278
	23,409	Federal National Mortgage Association Pool	4.00%	1/41		24,614
	22,580	Federal Home Loan Mortgage Corporation Pool	4.00%	1/41		23,803
	20,527	Federal National Mortgage Association Pool	5.00%	8/41		22,172
	19,704	Federal National Mortgage Association Pool	5.00%	6/41		21,302
	19,484	Federal Home Loan Mortgage Corporation Pool	5.00%	7/41		21,026
	19,904	Federal National Mortgage Association Pool	4.00%	1/41		20,929
	17,826	Federal National Mortgage Association Pool	5.00%	3/41		19,349
	16,363	Federal Home Loan Mortgage Corporation Pool	5.00%	4/41		17,658
	15,762	Federal National Mortgage Association Pool	5.00%	2/41		17,198
	15,039	Federal Home Loan Mortgage Corporation Pool	4.50%	9/40		15,988
	14,587	Federal Home Loan Mortgage Corporation Pool	4.00%	12/40		15,313
	13,298	Federal National Mortgage Association Pool	5.00%	4/41		14,376
	13,185	Federal Home Loan Mortgage Corporation Pool	5.00%	7/41		14,344
	12,160	Government National Mortgage Association Pool	5.50%	8/39		13,502
	12,018	Federal National Mortgage Association Pool	4.00%	2/41		12,637
	11,790	Federal National Mortgage Association Pool	4.00%	10/41		12,390
	11,247	Federal National Mortgage Association Pool	4.00%	11/40		11,833
	10,538	Federal Home Loan Mortgage Corporation Pool	4.00%	1/41		11,069
	10,060	Federal Home Loan Mortgage Corporation Pool	4.50%	8/41		10,683
	10,135	Federal Home Loan Mortgage Corporation Pool	4.00%	2/41		10,646
	9,955	Federal National Mortgage Association Pool	4.50%	3/41		10,605
	9,230	Federal Home Loan Mortgage Corporation Pool	4.50%	2/41		9,819
	8,881	Federal National Mortgage Association Pool	5.50%	10/39		9,708
	9,160	Federal National Mortgage Association Pool	4.00%	1/41		9,649
	9,066	Federal National Mortgage Association Pool	4.00%	9/41		9,528
	8,635	Federal Home Loan Mortgage Corporation Pool	4.00%	3/41		9,081
	8,137	Federal National Mortgage Association Pool	4.00%	10/41		8,556
	7,950	Federal Home Loan Mortgage Corporation Pool	4.50%	8/41		8,446
	7,530	Federal National Mortgage Association Pool	5.00%	7/41		8,136
	7,223	Federal National Mortgage Association Pool	5.00%	6/41		7,809
	7,153	Federal National Mortgage Association Pool	5.00%	8/41		7,742
	6,890	Federal National Mortgage Association Pool	5.00%	5/41		7,442
	6,355	Federal Home Loan Mortgage Corporation Pool	6.00%	4/39		6,991
	6,372	Federal National Mortgage Association Pool	4.50%	4/41		6,776
	5,830	Federal National Mortgage Association Pool	4.00%	7/41		6,159
	5,622	Federal National Mortgage Association Pool	5.00%	11/40		6,073
	5,576	Federal Home Loan Mortgage Corporation Pool	4.00%	5/41		5,850
	4,819	Federal National Mortgage Association Pool	5.00%	6/40		5,219
	4,856	Federal National Mortgage Association Pool	4.50%	4/41		5,176
	4,178	Federal Home Loan Mortgage Corporation Pool	4.00%	1/41		4,386
	3,412	Federal National Mortgage Association Pool	5.00%	4/41		3,687
	2,935	Federal Home Loan Mortgage Corporation Pool	4.50%	8/41		3,135
	9,468	Other Federal National Mortgage Association Pools	4.00% - 6.00%	9/39 - 9/41		10,166
	1,200	Other Federal Home Loan Mortgage Corporation Pool	6.00%	5/40		1,320
	1,151	Other Government National Mortgage Association Pool	5.50%	3/41		1,275

						775,718

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT SEPTEMBER 30, 2011 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate	Maturity	Value
(In thousands)					Expressed in U.S. Dollars
	Interest Only - Fixed Rate Agency Securities (1.39%)
$	22,398	Other Federal National Mortgage Association	5.00% - 5.50%	8/36 - 10/40	$	2,594
	14,667	Other Federal Home Loan Mortgage Corporation	5.00% - 5.50%	6/33 - 1/39		1,977
	10,369	Other Government National Mortgage Association	5.50%	3/36		669


						5,240

	TBA - Fixed Rate Agency Securities (14.07%) (c)
	49,000	Federal National Mortgage Association Pool (30 Year)	4.50%	10/11		51,986
	1,000	Other Federal Home Loan Mortgage Corporation Pool (30 Year)	3.50%	10/11		1,027

						53,013

	Total Fixed Rate Agency Securities (Cost $820,069)					833,971


	Floating Rate Agency Securities (14.04%)

	Principal and Interest - Floating Rate Agency Securities (13.98%)
	10,528	Federal National Mortgage Association Pool	5.12%	5/38		11,100
	10,018	Federal National Mortgage Association Pool	5.70%	1/38		10,615
	7,492	Federal National Mortgage Association Pool	5.28%	2/38		7,875
	7,387	Federal National Mortgage Association Pool	5.24%	12/35		7,785
	4,017	Federal National Mortgage Association Pool	5.55%	7/37		4,319
	3,503	Federal National Mortgage Association Pool	5.68%	4/36		3,718
	3,390	Federal Home Loan Mortgage Corporation Pool	2.71%	7/34		3,556
	2,018	Federal National Mortgage Association Pool	5.47%	9/37		2,144
	1,445	Other Federal National Mortgage Association Pool	5.01%	10/33		1,529

						52,641


	Interest Only - Floating Rate Agency Securities (0.06%)
	1,544	Other Federal National Mortgage Association Pool	5.50%	8/36		221

						221


	Total Floating Rate Agency Securities (Cost $52,347)					52,862


	Total Agency Securities (Cost $872,416)					886,833


	Private Label Securities (109.15%)

	Principal and Interest - Private Label Securities (108.90%)
	696,241	Various	0.29% - 9.35%	5/19 - 7/49		410,216


	Total Principal and Interest - Private Label Securities (Cost $432,247)					410,216


	Interest Only - Private Label Securities (0.25%)
	74,219	Various	0.50% - 0.65%	9/47		927


	Total Interest Only - Private Label Securities (Cost $635)					927


	Residual Certificates - Private Label Securities (0.00%)
	206,757	Various	—	6/37		—


	Total Residual Certificates - Private Label Securities (Cost $560)					—


	Total Private Label Securities (Cost $433,442)					411,143


	Total Mortgage-Backed Securities (Cost $1,305,858)					1,297,976


	Commercial Mortgage Loans (1.16%) (o)
	5,000	Various	5.75%	11/12		4,375


	Total Commercial Mortgage Loans (Cost $4,767)					4,375


	Total Long Investments (Cost $1,310,625)				$	1,302,351

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT SEPTEMBER 30, 2011 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate			Maturity		Value
(In thousands)								Expressed in U.S. Dollars
	Repurchase Agreements (4.79%) (d)
$	15,712	Nomura Securities International Inc. Collateralized by Par Value $15,000 U.S. Treasury Note, Coupon 1.75%, Maturity Date 5/16		0.03	%		10/11	$	15,712
	2,323	Nomura Securities International Inc. Collateralized by Par Value $2,000 U.S. Treasury Note, Coupon 3.63%, Maturity Date 2/21		0.03	%		10/11		2,323


	Total Repurchase Agreements (Cost $18,035)							$	18,035


	Investments Sold Short (-149.38%)

	TBA - Fixed Rate Agency Securities Sold Short (-144.62%) (c) (e)
$	(127,500)	Federal National Mortgage Association Pool (30 Year)		5.00	%		10/11	$	(137,122	)
	(96,000)	Government National Mortgage Association Pool (30 Year)		5.00	%		10/11		(105,435	)
	(93,700)	Federal Home Loan Mortgage Corporation Pool (30 Year)		4.50	%		10/11		(99,146	)
	(78,400)	Federal National Mortgage Association Pool (30 Year)		4.00	%		10/11		(82,192	)
	(40,000)	Federal Home Loan Mortgage Corporation Pool (30 Year)		4.50	%		11/11		(42,225	)
	(31,500)	Federal Home Loan Mortgage Corporation Pool (30 Year)		5.00	%		10/11		(33,776	)
	(15,600)	Federal Home Loan Mortgage Corporation Pool (30 Year)		4.00	%		10/11		(16,328	)
	(13,500)	Government National Mortgage Association Pool (30 Year)		5.50	%		10/11		(14,927	)
	(8,500)	Federal National Mortgage Association Pool (30 Year)		5.50	%		10/11		(9,225	)
	(2,500)	Federal National Mortgage Association Pool (30 Year)		6.00	%		10/11		(2,742	)
	(1,000)	Other Federal Home Loan Mortgage Corporation Pool (30 Year)		6.00	%		10/11		(1,096	)
	(500)	Other Government National Mortgage Association Pool (30 Year)		4.50	%		10/11		(543	)


	Total TBA - Fixed Rate Agency Securities Sold Short (Proceeds -$545,465)								(544,757	)


	U.S. Treasury Securities Sold Short (-4.76%)
	(17,000)	U.S. Treasury Note		1.75% - 3.63	%		5/16 - 2/21		(17,913	)


	Total U.S. Treasury Securities Sold Short (Proceeds -$17,142)								(17,913	)


	Total Investments Sold Short (Proceeds -$562,607)							$	(562,670	)

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT SEPTEMBER 30, 2011 (CONTINUED)

(UNAUDITED)


	Primary Risk Exposure	Notional			Range of Expiration Dates	Value
(In thousands)						Expressed in U.S. Dollars
Financial Derivatives - Assets (29.58%)
Swaps (29.58%) (f)
Long Swaps:
Interest Rate Swaps (g)	Interest Rates	$	600		9/21	$	3
Short Swaps:
Credit Default Swaps on Asset Backed Securities (h)	Credit		(74,453	)	9/34 - 12/36		59,906
Credit Default Swaps on Asset Backed Indices: (i)	Credit
ABX.HE AAA 2006-2 Index			(68,967	)	5/46		39,110
Other			(29,857	)	8/37 - 2/51		11,431
Total Return Swaps (j)	Equity Market		(14,613	)	9/12 - 9/13		827
Credit Default Swaps on Corporate Bond Indices (k)	Credit		(19,700	)	6/15		109
Interest Rate Swaps (l)	Interest Rates		(970	)	9/21		19

Total Swaps (Cost $119,307)							111,405

Total Financial Derivatives - Assets (Cost $119,307)						$	111,405

Financial Derivatives - Liabilities (-9.29%)
Swaps (-9.29%)
Long Swaps:
Credit Default Swaps on Asset Backed Indices (Proceeds - $13,825) (m)	Credit	$	26,907		8/37 - 2/51	$	(15,467	)
Interest Rate Swaps (g)	Interest Rates		10,000		9/16		(72	)
Short Swaps:
Interest Rate Swaps (l)	Interest Rates		(309,800	)	4/14 - 7/21		(19,449	)

Total Swaps (Proceeds -$13,825)						$	(34,988	)

Total Financial Derivatives - Liabilities (Net Proceeds -$13,825)						$	(34,988	)

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT SEPTEMBER 30, 2011 (CONCLUDED)

(UNAUDITED)

(a)	See Note 2 and Note 9 in Notes to Consolidated Financial Statements.

(b)	At September 30, 2011, the Company’s long investments guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association represented 126.76%, 83.53%, and 25.15% of shareholders’ equity, respectively.

(c)	To Be Announced (“TBA”) securities settle on a forward basis. At settlement the purchaser generally receives agency pass-through mortgage certificates with original maturity dates typically between 15 and 30 years.

(d)	In general, securities received pursuant to repurchase agreements were delivered to counterparties in short sale transactions.

(e)	At September 30, 2011, the Company’s short investments guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association represented 61.40%, 51.12%, and 32.10% of shareholders’ equity, respectively.

(f)	The following table shows the Company’s swap assets by dealer as a percentage of shareholders’ equity:


Dealer/Parent Company	Percent of Shareholders’ Equity
Affiliates of Morgan Stanley		10.87	%
Affiliates of Credit Suisse		5.41	%
Affiliates of Deutsche Bank		5.08	%

(g)	For long interest rate swap contracts, a floating rate is being paid and a fixed rate is being received.

(h)	For short credit default swaps on asset backed securities, the Company purchased protection.

(i)	For short credit default swaps on asset backed indices, the Company purchased protection.

(j)	Notional amount represents number of underlying shares or par value times the closing price of the underlying security.

(k)	For short credit default swaps on corporate bond indices, the Company purchased protection.

(l)	For short interest rate swap contracts, a fixed rate is being paid and a floating rate is being received.

(m)	For long credit default swaps on asset backed indices, the Company sold protection.

(n)

The table below shows the Company’s long investment ratings from Moody’s, Standard and Poor’s, or Fitch, as well as the Company’s long investments that were unrated but affiliated with Fannie Mae, Freddie Mac, or Ginnie Mae. Ratings tend to be a lagging credit indicator; as a result, the credit quality of the Company’s long investment holdings may be lower than the credit quality implied based on the ratings listed below. In situations where an investment has a split rating, the lowest provided rating is used. The ratings descriptions include ratings qualified with a “+”, “-”, “1”, “2”, or “3”.


Rating Description	Percentage of Shareholders’ Equity
Unrated but Agency-Guaranteed		235.44	%
Aaa/AAA/AAA		1.48	%
Aa/AA/AA		2.02	%
A/A/A		5.81	%
Baa/BBB/BBB		3.70	%
Ba/BB/BB or below		96.14	%
Unrated		1.16	%

(o)	Maturity date may be extended through November 4, 2015.

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate			Maturity	Value
(In thousands)							Expressed in U.S. Dollars
	Long Investments (308.68%) (a) (b) (n)

	Mortgage-Backed Securities (308.68%)

	Agency Securities (224.28%)

	Fixed Rate Agency Securities (204.19%)

	Principal and Interest - Fixed Rate Agency Securities (190.72%)

$	93,296	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40	$	92,662
	75,287	Government National Mortgage Association Pool		5.00	%	4/40		80,769
	41,442	Federal National Mortgage Association Pool		5.00	%	8/40		43,660
	31,029	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		30,806
	29,867	Federal Home Loan Mortgage Corporation Pool		4.50	%	9/40		30,665
	27,829	Federal National Mortgage Association Pool		4.50	%	11/40		28,596
	25,016	Government National Mortgage Association Pool		4.50	%	5/40		26,108
	24,331	Federal Home Loan Mortgage Corporation Pool		5.00	%	8/40		25,551
	20,674	Federal National Mortgage Association Pool		5.00	%	11/40		21,783
	20,370	Federal National Mortgage Association Pool		3.50	%	11/40		19,453
	17,518	Federal Home Loan Mortgage Corporation Pool		5.00	%	9/40		18,396
	17,827	Federal Home Loan Mortgage Corporation Pool		4.50	%	11/40		18,298
	16,318	Federal National Mortgage Association Pool		5.00	%	10/40		17,234
	16,073	Federal National Mortgage Association Pool		4.50	%	12/40		16,526
	15,061	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		14,958

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate			Maturity	Value
(In thousands)							Expressed in U.S. Dollars
	Principal and Interest - Fixed Rate Agency Securities (190.72% ) (continued)

	$14,674	Federal National Mortgage Association Pool		4.00	%	11/40	$	14,602
	14,053	Federal National Mortgage Association Pool		4.00	%	12/40		14,008
	14,086	Federal National Mortgage Association Pool		3.50	%	1/41		13,451
	11,888	Federal National Mortgage Association Pool		4.50	%	9/40		12,209
	11,074	Government National Mortgage Association Pool		5.00	%	6/40		11,859
	11,018	Federal National Mortgage Association Pool		4.50	%	7/25		11,574
	9,887	Government National Mortgage Association Pool		5.00	%	7/40		10,523
	9,534	Federal National Mortgage Association Pool		5.50	%	10/39		10,238
	9,622	Federal National Mortgage Association Pool		4.50	%	8/25		10,110
	9,697	Federal Home Loan Mortgage Corporation Pool		4.50	%	11/40		9,953
	9,185	Government National Mortgage Association Pool		5.00	%	4/40		9,837
	8,436	Federal Home Loan Mortgage Corporation Pool		4.50	%	10/40		8,648
	7,945	Federal Home Loan Mortgage Corporation Pool		6.00	%	4/39		8,633
	8,224	Federal Home Loan Mortgage Corporation Pool		5.00	%	8/40		8,637
	7,307	Federal National Mortgage Association Pool		5.00	%	7/40		7,690
	7,189	Government National Mortgage Association Pool		5.00	%	8/40		7,699
	7,203	Federal Home Loan Mortgage Corporation Pool		4.00	%	11/40		7,166
	6,727	Federal National Mortgage Association Pool		5.00	%	8/40		7,087
	6,194	Government National Mortgage Association Pool		5.00	%	7/40		6,593

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate			Maturity	Value
(In thousands)							Expressed in U.S. Dollars
	Principal and Interest - Fixed Rate Agency Securities (190.72% ) (continued)

	$5,820	Federal National Mortgage Association Pool		6.00	%	12/38	$	6,327
	6,262	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		6,219
	6,096	Federal National Mortgage Association Pool		4.00	%	11/40		6,064
	6,097	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		6,066
	5,703	Federal National Mortgage Association Pool		4.50	%	8/25		5,989
	5,433	Federal National Mortgage Association Pool		5.00	%	11/40		5,723
	5,093	Federal National Mortgage Association Pool		4.50	%	8/25		5,348
	5,082	Federal National Mortgage Association Pool		4.50	%	12/40		5,222
	4,812	Federal National Mortgage Association Pool		4.50	%	11/40		4,945
	4,377	Federal National Mortgage Association Pool		5.50	%	11/39		4,689
	4,637	Federal Home Loan Mortgage Corporation Pool		4.00	%	1/41		4,605
	4,394	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		4,372
	4,003	Government National Mortgage Association Pool		5.00	%	7/40		4,261
	3,612	Federal National Mortgage Association Pool		4.50	%	12/40		3,712
	3,218	Federal Home Loan Mortgage Corporation Pool		5.00	%	9/40		3,383
	3,356	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		3,338
	2,932	Federal National Mortgage Association Pool		4.50	%	9/25		3,074
	2,779	Federal Home Loan Mortgage Corporation Pool		4.00	%	8/40		2,765
	2,157	Federal Home Loan Mortgage Corporation Pool		4.00	%	12/40		2,146
	5,210	Other Federal National Mortgage Association Pools		6.00	%	9/39 - 2/40		5,665

								769,895

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate			Maturity	Value
(In thousands)							Expressed in U.S. Dollars
	TBA - Fixed Rate Agency Securities (13.47% ) (c)
	$25,000	Government National Mortgage Association (30 Year)		4.00	%	1/11	$	25,152
	25,000	Federal National Mortgage Association (30 Year)		4.00	%	2/11		24,797
	4,650	Federal National Mortgage Association (30 Year)		3.50	%	1/11		4,441

								54,390

	Total Fixed Rate Agency Securities (Cost $828,147)							824,285


	Floating Rate Agency Securities (20.09% )

	Principal and Interest - Floating Rate Agency Securities (20.09% )

	15,367	Federal National Mortgage Association Pool		5.84	%	12/36		16,266
	12,274	Federal National Mortgage Association Pool		5.68	%	1/38		13,025
	11,854	Federal National Mortgage Association Pool		5.10	%	5/38		12,476
	10,984	Federal National Mortgage Association Pool		5.22	%	12/35		11,568
	8,928	Federal National Mortgage Association Pool		5.76	%	10/36		9,392
	8,641	Federal National Mortgage Association Pool		5.22	%	2/38		9,127
	4,123	Federal National Mortgage Association Pool		5.69	%	4/36		4,380
	3,012	Federal National Mortgage Association Pool		5.50	%	9/37		3,173
	1,608	Federal National Mortgage Association Pool		6.06	%	1/38		1,686

	Total Principal and Interest - Floating Rate Agency Securities (Cost $80,167)							81,093

	Total Floating Rate Agency Securities (Cost $80,167)							81,093


	Total Agency Securities (Cost $908,314)							905,378

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate		Maturity	Value
(In thousands)						Expressed in U.S. Dollars
	Private Label Securities (84.40%)

	Principal and Interest - Private Label Securities (82.97%)
	$ 482,838	Various		0.32% - 53.41%	6/18 - 2/51	$	334,909


	Total Principal and Interest - Private Label Securities (Cost $321,068)						334,909


	Interest Only - Private Label Securities (1.43%)
	127,239	Various		0.50% - 5.24%	4/35 - 9/47		5,780


	Total Interest Only - Private Label Securities (Cost $2,491)						5,780


	Residual Certificates - Private Label Securities (0.00%)
	225,640	Various		—	6/37		—


	Total Residual Certificates - Private Label Securities (Cost $611)						—


	Total Private Label Securities (Cost $324,170)						340,689


	Total Mortgage-Backed Securities (Cost $1,232,484)						1,246,067


	Total Long Investments (Cost $1,232,484)					$	1,246,067


	Repurchase Agreements (6.36%) (d)
	$ 25,684	Credit Suisse First Boston Collateralized by Par Value $27,000 U.S. Treasury Note, Coupon 2.63%, Maturity Date 11/20		0.00%	1/11	$	25,684


	Total Repurchase Agreements (Cost $25,684)					$	25,684

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONTINUED)

(UNAUDITED)


Current Principal/ Notional Amount		Description	Rate			Maturity	Value
(In thousands)							Expressed in U.S. Dollars
	Investments Sold Short (-192.02%)

	TBA - Fixed Rate Agency Securities Sold Short (-185.71%) (c) (e)
	$(136,500)	Federal National Mortgage Association (30 Year)		4.50	%	1/11	$	(140,094	)
	(113,000)	Government National Mortgage Association (30 Year)		5.00	%	1/11		(120,168	)
	(114,500)	Federal National Mortgage Association (30 Year)		4.00	%	1/11		(113,901	)
	(62,000)	Federal National Mortgage Association (30 Year)		5.00	%	1/11		(65,172	)
	(63,000)	Federal Home Loan Mortgage Corporation (30 Year)		4.00	%	1/11		(62,547	)
	(40,000)	Federal Home Loan Mortgage Corporation (30 Year)		4.00	%	2/11		(39,594	)
	(35,000)	Federal National Mortgage Association (15 Year)		4.50	%	1/11		(36,698	)
	(33,000)	Federal Home Loan Mortgage Corporation (30 Year)		5.00	%	1/11		(34,614	)
	(30,000)	Government National Mortgage Association (30 Year)		5.00	%	2/11		(31,842	)
	(27,500)	Federal Home Loan Mortgage Corporation (30 Year)		4.50	%	1/11		(28,175	)
	(24,500)	Government National Mortgage Association (30 Year)		4.50	%	1/11		(25,432	)
	(25,000)	Government National Mortgage Association (30 Year)		4.00	%	1/11		(25,172	)
	(16,000)	Federal Home Loan Mortgage Corporation (30 Year)		5.50	%	1/11		(17,053	)
	(7,500)	Federal National Mortgage Association (30 Year)		6.00	%	1/11		(8,153	)
	(1,000)	Federal National Mortgage Association (30 Year)		5.50	%	2/11		(1,068	)


	Total TBA - Fixed Rate Agency Securities Sold Short (Proceeds - $750,520)							(749,683	)


	U.S. Treasury Securities Sold Short (-6.31%)
	(27,000)	U.S. Treasury Note		2.63	%	11/20		(25,462	)


	Total U.S. Treasury Securities Sold Short (Proceeds - $25,262)							(25,462	)


	Total Investments Sold Short (Proceeds -$775,782)						$	(775,145	)

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONTINUED)

(UNAUDITED)


	Primary Risk Exposure	Notional			Range of Expiration Dates	Value
(In thousands)						Expressed in U.S. Dollars
Financial Derivatives - Assets (49.88%)
Swaps (49.88%) (f)
Long Swaps:
Credit Default Swaps on Asset Backed Indices (Cost $4,033) (g)	Credit	$	74,128		6/36 - 7/36	$	3,567
Interest Rate Swaps (h)	Interest Rates		5,000		12/20		47
Short Swaps:
Credit Default Swaps on Asset Backed Securities (i)	Credit		(127,089	)	6/34 - 12/36		102,850
Credit Default Swaps on Asset Backed Indices: (j)	Credit
ABX.HE AAA 2007-1 Index			(108,595	)	8/37		60,649
Other			(92,449	)	8/37 - 2/51		32,474
Interest Rate Swaps (k)	Interest Rates		(60,000	)	12/15 - 12/20		1,748

Total Swaps (Cost $208,958)							201,335

Total Financial Derivatives - Assets (Cost $208,958)						$	201,335

Financial Derivatives - Liabilities (-5.21%)
Swaps (-4.99%)
Long Swaps:
Credit Default Swaps on Asset Backed Indices (Proceeds - $17,559) (g)	Credit	$	37,589		8/37 - 12/49	$	(17,942	)
Interest Rate Swaps (h)	Interest Rates		10,000		11/15 - 11/20		(215	)
Short Swaps:
Interest Rate Swaps (k)	Interest Rates		(83,750	)	10/14 - 12/15		(1,461	)
Credit Default Swaps on Asset Backed Indices (j)	Credit		(4,435	)	7/36		(336	)
Credit Default Swaps on Corporate Bond Indices (l)	Credit		(19,700	)	6/15		(186	)

Total Swaps (Net Proceeds - $17,718)							(20,140	)

Futures (-0.22%)
Short Futures:
Eurodollar contracts (m)	Interest Rates		(400,000	)	3/11 - 9/12		(890	)

Total Futures							(890	)

Total Financial Derivatives - Liabilities (Net Proceeds - $17,718)						$	(21,030	)

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS

AT DECEMBER 31, 2010 (CONCLUDED)

(UNAUDITED)

(a)	See Note 2 and Note 9 in Notes to Consolidated Financial Statements.

(b)	At December 31, 2010, the Company’s long investments guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association represented 102.88%, 76.12%, and 45.28% of shareholders’ equity, respectively.

(c)	To Be Announced (“TBA”) securities settle on a forward basis. At settlement the purchaser generally receives agency pass-through mortgage certificates with original maturity dates typically between 15 and 30 years.

(d)	In general, securities received pursuant to repurchase agreements were delivered to counterparties in short sale transactions.

(e)	At December 31, 2010, the Company’s short investments guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association represented 90.44%, 45.08%, and 50.19% of shareholders’ equity, respectively.

(f)	The following table shows the Company’s swap assets by dealer as a percentage of shareholders’ equity:


Dealer/Parent Company	Percent of Shareholders’ Equity
Affiliates of Morgan Stanley		19.22	%
Affiliates of Credit Suisse		9.07	%

(g)	For long credit default swaps on asset backed indices, the Company sold protection.

(h)	For long interest rate swap contracts, a floating rate is being paid and a fixed rate is being received.

(i)	For short credit default swaps on asset backed securities, the Company purchased protection.

(j)	For short credit default swaps on asset backed indices, the Company purchased protection.

(k)	For short interest rate swap contracts, a fixed rate is being paid and a floating rate is being received.

(l)	For short credit default swaps on corporate bond indices, the Company purchased protection.

(m)	Represents $1,000,000 notional amount per contract.

(n)


Rating Description	Percentage of Shareholders’ Equity
Unrated but Agency-Guaranteed		224.28	%
Aaa/AAA/AAA		6.81	%
Aa/AA/AA		13.91	%
A/A/A		4.46	%
Baa/BBB/BBB		6.00	%
Ba/BB/BB or below		53.22	%
Unrated		0.00	%

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED STATEMENT OF OPERATIONS

(UNAUDITED)


	Three Month Period Ended September 30, 2011			Three Month Period Ended September 30, 2010			Nine Month Period Ended September 30, 2011			Nine Month Period Ended September 30, 2010
(In thousands except per share amounts)	*Expressed in U.S. Dollars*
INVESTMENT INCOME
Interest income	$	15,597		$	10,859		$	48,098		$	33,574

EXPENSES
Base management fee		1,418			1,173			4,347			3,385
Incentive fee		—			2,524			612			3,007
Share-based LTIP expense		41			460			116			1,960
Interest expense		1,627			921			4,773			2,601
Professional fees		457			543			1,369			1,445
Compensation expense		428			210			1,079			710
Insurance expense		176			285			533			845
Agency and administration fees		225			185			715			531
Custody and other fees		191			167			707			426
Directors’ fees and expenses		57			69			198			202

Total expenses		4,620			6,537			14,449			15,112

NET INVESTMENT INCOME (LOSS)		10,977			4,322			33,649			18,462

NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FINANCIAL DERIVATIVES
Net realized gain (loss) on:
Investments		1,570			(2,697	)		(1,215	)		9,618
Swaps		6,779			(3,868	)		17,971			3,352
Futures		(375	)		(581	)		(1,094	)		(1,607	)
Purchased options		—			—			—			(581	)

		7,974			(7,146	)		15,662			10,782

Change in net unrealized gain (loss) on:
Investments		(9,003	)		23,769			(22,555	)		16,716
Swaps		(11,477	)		(4,348	)		(19,020	)		(17,229	)
Futures		369			(579	)		890			(1,928	)
Purchased options		—			—			—			542

		(20,111	)		18,842			(40,685	)		(1,899	)

NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FINANCIAL DERIVATIVES		(12,137	)		11,696			(25,023	)		8,883

NET INCREASE (DECREASE) IN SHAREHOLDERS’ EQUITY RESULTING FROM OPERATIONS	$	(1,160	)	$	16,018		$	8,626		$	27,345

NET INCREASE (DECREASE) IN SHAREHOLDERS’ EQUITY RESULTING FROM OPERATIONS PER SHARE:
Basic and Diluted	$	(0.07	)	$	1.30		$	0.51		$	2.21

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)


	Three Month Period Ended September 30, 2011			Three Month Period Ended September 30, 2010			Nine Month Period Ended September 30, 2011			Nine Month Period Ended September 30, 2010
(In thousands)	*Expressed in U.S. Dollars*
CHANGE IN SHAREHOLDERS’ EQUITY RESULTING FROM OPERATIONS
Net investment income (loss)	$	10,977		$	4,322		$	33,649		$	18,462
Net realized gain (loss) on investments and financial derivatives		7,974			(7,146	)		15,662			10,782
Change in net unrealized gain (loss) on investments and financial derivatives		(20,111	)		18,842			(40,685	)		(1,899	)

Net increase (decrease) in shareholders’ equity resulting from operations		(1,160	)		16,018			8,626			27,345

CHANGE IN SHAREHOLDERS’ EQUITY RESULTING FROM SHAREHOLDER TRANSACTIONS
Shares issued in connection with incentive fee payment		—			—			203			275
Dividends paid		(6,752	)		(1,855	)		(35,634	)		(20,401	)
Shares repurchased		(309	)		—			(309	)		—
Share-based LTIP awards		41			460			116			1,960

Net increase (decrease) in shareholders’ equity from shareholder transactions		(7,020	)		(1,395	)		(35,624	)		(18,166	)

Net increase (decrease) in shareholders’ equity		(8,180	)		14,623			(26,998	)		9,179
SHAREHOLDERS’ EQUITY, BEGINNING OF PERIOD		384,854			294,350			403,672			299,794

SHAREHOLDERS’ EQUITY, END OF PERIOD	$	376,674		$	308,973		$	376,674		$	308,973

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)


	Nine Month Period Ended September 30, 2011			Nine Month Period Ended September 30, 2010
(In thousands)	*Expressed in U.S. Dollars*
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS:
NET INCREASE (DECREASE) IN SHAREHOLDERS’ EQUITY
RESULTING FROM OPERATIONS	$	8,626		$	27,345
Cash flows provided by (used in) operating activities:
Reconciliation of the net increase (decrease) in shareholders’ equity resulting from operations to net cash provided by (used in) operating activities:
Change in net unrealized (gain) loss on investments and financial derivatives		40,685			1,899
Net realized (gain) loss on investments and financial derivatives		(15,662	)		(10,782	)
Amortization of premiums and accretion of discounts (net)		(7,857	)		(5,749	)
Purchase of investments		(2,695,989	)		(2,298,599	)
Proceeds from disposition of investments		2,582,023			1,808,694
Proceeds from principal payments of investments		75,595			88,707
Proceeds from investments sold short		980,116			894,958
Repurchase of investments sold short		(1,226,418	)		(529,748	)
Payments made to open financial derivatives		(119,933	)		(219,776	)
Proceeds received to close financial derivatives		224,232			177,148
Proceeds received to open financial derivatives		25,878			73,352
Payments made to close financial derivatives		(27,540	)		(52,642	)
Shares issued in connection with incentive fee payment		203			275
Share-based LTIP expense		116			1,960
(Increase) decrease in assets:
(Increase) decrease in repurchase agreements		7,649			—
(Increase) decrease in receivable for securities sold		(91,287	)		(512,709	)
(Increase) decrease in deposits with dealers held as collateral		(16,275	)		4,988
(Increase) decrease in interest and principal receivable		(1,689	)		4,055
(Increase) decrease in other assets		(157	)		(249	)
Increase (decrease) in liabilities:
Increase (decrease) in due to brokers - margin accounts		(74,345	)		(678	)
Increase (decrease) in payable for securities purchased		269,450			666,149
Increase (decrease) in accounts payable and accrued expenses		(204	)		1,036
Increase (decrease) in incentive fee payable		(1,422	)		250
Increase (decrease) in interest and dividends payable		88			(276	)
Increase (decrease) in base management fee payable		(107	)		35

Net cash provided by (used in) operating activities		(64,224	)		119,643

Cash flows provided by (used in) financing activities:
Shares repurchased		(309	)		—
Offering costs paid		(469	)		(1,138	)
Dividends paid		(35,634	)		(20,401	)
Reverse repurchase agreements, net of repayments		106,456			(83,255	)

Net cash provided by (used in) financing activities		70,044			(104,794	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		5,820			14,849
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		35,791			102,863

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	41,611		$	117,712

Supplemental disclosure of cash flow information:
Interest paid	$	4,714		$	2,796

Shares issued in connection with incentive fee payment (non-cash)	$	203		$	275

Share-based LTIP awards (non-cash)	$	116		$	1,960

Aggregate TBA trade activity (buys + sells) (non-cash)	$	16,291,487		$	10,645,380

See Notes to Consolidated Financial Statements

ELLINGTON FINANCIAL LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(UNAUDITED)

1. Organization and Investment Objective

Ellington Financial LLC was formed as a Delaware limited liability company on July 9, 2007 and commenced operations on August 17, 2007 upon the completion of its initial private capitalization. EF Securities LLC, a wholly owned consolidated subsidiary of Ellington Financial LLC, was formed as a Delaware limited liability company on October 12, 2007 and commenced operations on November 30, 2007. EF Mortgage LLC, a wholly owned consolidated subsidiary of Ellington Financial LLC, was formed as a Delaware limited liability company on June 3, 2008 and commenced operations on July 8, 2008. EF CMO LLC, a wholly owned consolidated subsidiary of EF Mortgage LLC, was formed as a Delaware limited liability company on June 3, 2008 and commenced operations on July 8, 2008. Ellington Financial LLC, EF Securities LLC, EF Mortgage LLC and EF CMO LLC are hereafter collectively referred to as the “Company.” All inter-company accounts are eliminated in consolidation.

On October 14, 2010, the Company closed its initial public offering of its common shares representing limited liability company interests, or common shares, pursuant to which it sold 4,500,000 common shares to the public at a public offering price of $22.50. The Company raised approximately $101.3 million in gross proceeds, resulting in net proceeds of approximately $94.7 million after deducting underwriting discounts and other offering costs. The Company’s common shares trade on the New York Stock Exchange under the symbol “EFC.”

The Company is a specialty finance company that acquires and manages mortgage-related assets, including residential mortgage-backed securities, or “RMBS,” backed by prime jumbo, Alt-A and subprime residential mortgage loans, RMBS for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, mortgage-related derivatives, commercial mortgage-backed securities, or “CMBS,” commercial mortgage loans and other commercial real estate debt, as well as corporate debt and equity securities and derivatives. The Company may also opportunistically acquire and manage other types of mortgage-related and financial asset classes, such as residential whole mortgage loans, asset-backed securities, or “ABS,” backed by consumer and commercial assets and non-mortgage-related derivatives.

Ellington Financial Management, LLC (“EFM” or the “Manager”) is a registered investment advisor that serves as the Manager to the Company pursuant to the terms of the Third Amended and Restated Management Agreement effective August 2, 2011 (the “Management Agreement”). EFM is an affiliate of Ellington Management Group, L.L.C., an investment management firm and also a registered investment advisor. In accordance with the terms of the Management Agreement, the Manager implements the investment strategy and manages the business and operations on a day-to-day basis for the Company and performs certain services for the Company, subject to oversight by the Board of Directors.

2. Significant Accounting Policies

(A) Basis of Presentation: The Company’s unaudited interim consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America for investment companies, ASC 946, Financial Services—Investment Companies (“ASC 946”), for interim financial information. ASC 946 requires, among other things, that investments be reported at fair value in the financial statements. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year.

(B) Valuation: The Company applies ASC 820-10, Fair Value Measurement and Disclosures (“ASC 820-10”), to its holdings of financial instruments. ASC 820-10 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

•

Level 1—inputs to the valuation methodology are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets,

•

Level 2—inputs to the valuation methodology other than quoted prices included in Level 1 are observable for the asset or liability, either directly or indirectly, and

•

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

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in these securities.

(C) Securities Transactions and Investment Income: Securities transactions are generally recorded on trade date. Realized and unrealized gains and losses are calculated based on identified cost. Interest income, which includes accretion of discounts and amortization of premiums on mortgage-backed securities, including investments in mortgage loans, or “MBS,” and U.S. Treasury holdings, is recognized over the life of the investment using the effective interest method. For purposes of determining the effective interest rate, management estimates the future expected cash flows of its investment holdings based on assumptions including, but not limited to, prepayment and default rate assumptions. These assumptions are reevaluated not less than quarterly and require the use of a significant amount of judgment. Principal write-offs are generally treated as realized losses.

(D) Cash and Cash Equivalents: On the Consolidated Statement of Cash Flows the Company has revised prior period classifications to conform to current period presentation. Cash and cash equivalents include amounts held in an interest bearing overnight account and money market funds. As of September 30, 2011, all cash was held in an interest bearing account at the Bank of New York Mellon Corporation. As of December 31, 2010, 70% and 30% of cash and cash equivalents were held in the JP Morgan Prime Money Market Premier Fund and an interest bearing account at the Bank of New York Mellon Corporation, respectively.

(E) Financial Derivatives: The Company enters into various types of financial derivatives. The two major types utilized are swaps and futures.

Swaps: The Company may enter into various types of swaps, including interest rate swaps, credit default swaps, and total return swaps. The primary risk associated with the Company’s interest rate swap activity is interest rate risk. The primary risk associated with the Company’s total return swap activity has been equity market risk. The primary risk associated with the Company’s credit default swaps is credit risk.

The Company is subject to interest rate risk exposure in the normal course of pursuing its investment objectives. To help mitigate interest rate risk, the Company enters into interest rate swaps. Interest rate swaps are contractual agreements whereby one party pays a floating rate of interest on a notional principal amount and receives a fixed rate on the same notional principal, or vice versa, for a fixed period of time. Interest rate swaps change in value with movements in interest rates.

The Company enters into credit default swaps. A credit default swap is a contract under which one party agrees to compensate another party for the financial loss associated with the occurrence of a “credit event” in relation to a “reference amount” or notional amount of a credit obligation (usually a bond or loan). The definition of a credit event often varies from contract to contract. A credit event may occur (i) when the underlying reference asset(s) fails to make scheduled principal or interest payments to its holders, (ii) with respect to credit default swaps referencing mortgage/asset backed securities and indices, when the underlying reference obligation is downgraded below a certain rating level or (iii) with respect to credit default swaps referencing corporate entities and indices, upon the bankruptcy of the underlying reference obligor. The Company typically writes (sells) protection to take a “long” position or purchases (buys) protection to take a “short” position with respect to underlying reference assets or to hedge exposure to other investment holdings.

The Company enters into total return swaps in order to take a “long” or “short” position with respect to an underlying referenced asset. The Company is subject to market price volatility of the underlying referenced asset. A total return swap involves commitments to pay interest in exchange for a market-linked return based on a notional amount. To the extent that the total return of the security, group of securities or index underlying the transaction exceeds or falls short of the offsetting interest obligation, the Company will receive a payment from or make a payment to the counterparty.

Swaps change in value with movements in interest rates or total return of the referenced securities. During the term of swap contracts, changes in value are recognized as unrealized gains or losses. When the contracts are terminated, the Company will realize a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company’s basis in the contract, if any. Periodic payments or receipts required by swap agreements are recorded as unrealized gains or losses when accrued and realized gains or losses when received or paid. Upfront payments paid/received by the Company to open swap contracts are recorded as an asset and/or liability on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity and are recorded as a realized gain or loss on the termination date. The Company may be required to deliver or receive cash or securities as collateral upon entering into swap transactions.

The Company’s swap contracts are generally governed by ISDA trading agreements, which are separately negotiated agreements with dealer counterparties. Changes in the relative value of the swap transactions may require the Company or the counterparty to post or receive additional collateral. Typically, a collateral payment or receipt is triggered based on the net change in the value of all contracts governed by a particular ISDA trading agreement. Collateral received from counterparties is included in Due to brokers on margin accounts on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity. Collateral paid to counterparties is included in Deposits with dealers held as collateral on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity. Entering into swap contracts involves market risk in excess of amounts recorded on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity.

Futures Contracts: A futures contract is an agreement between two parties to buy and sell a financial instrument for a set price on a future date. The Company enters into Eurodollar futures contracts to hedge its interest rate risk. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking to market on a daily basis to reflect the market value of the contract at the end of each day’s trading. Variation margin payments are made or received periodically, depending upon whether unrealized gains or losses are incurred. When the contract is closed, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company’s basis in the contract.

Derivative instruments disclosed on the Consolidated Condensed Schedule of Investments include: credit default swaps on asset backed securities, credit default swaps on asset backed indices, credit default swaps on corporate bond indices, interest rate swaps, total return swaps, and Eurodollar futures contracts.

Swap assets are included in Financial derivatives—assets on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity. Swap liabilities are included in Financial derivatives—liabilities on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity. In addition, swap contracts are summarized by type on the Consolidated Condensed Schedule of Investments. Unrealized depreciation on futures contracts is included in Financial derivatives—liabilities on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity. For total return swaps, interest rate swaps, and credit default swaps, notional amounts reflected on the Consolidated Condensed Schedule of Investments represent approximately 1000%, 117%, and 69%, respectively, of average monthly notional amounts of each such category outstanding during the nine month period ended September 30, 2011. For interest rate swaps, credit default swaps, and futures, notional amounts reflected on the Consolidated Condensed Schedule of Investments represent approximately 318%, 133%, and 38%, respectively, of average monthly notional amounts of each such category outstanding during the year ended December 31, 2010. The Company uses average monthly notional amounts outstanding to indicate the volume of activity with respect to these instruments.

(F) Short Sales: When the Company sells securities short, it typically satisfies its security delivery settlement obligation by obtaining the security sold from the same or a different counterparty via repurchase agreement. The Company generally is required to deliver cash or securities as collateral to the repurchase agreement counterparty. A gain, limited to the price at which the Company sold the security short, or a loss, unlimited as to dollar amount, will be recognized upon the termination of a short sale if the market price is less than or greater than the proceeds originally received.

(G) Reverse Repurchase Agreements and Repurchase Agreements: The Company enters into reverse repurchase agreements with third-party broker-dealers whereby it sells securities under agreements to be repurchased at an agreed-upon price and date. Interest on the value of repurchase and reverse repurchase agreements issued and outstanding is based upon competitive market rates at the time of issuance. The Company accounts for reverse repurchase agreements as collateralized borrowings. When the Company enters into a reverse repurchase agreement, the lender establishes and maintains an account containing cash and securities having a value not less than the repurchase price, including accrued interest, of the reverse repurchase agreement. The Company enters into repurchase agreement transactions with third-party broker-dealers whereby it purchases securities under agreements to resell at an agreed-upon price and date. In general, securities received pursuant to repurchase agreements are delivered to counterparties of short sale transactions. Assets held pursuant to repurchase agreements are reflected as assets on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity. Repurchase and reverse repurchase agreements that are conducted with the same counterparty may be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet Offsetting. There are no repurchase and reverse repurchase agreements netted in the consolidated financial statements.

Reverse repurchase agreements are carried at their contractual amounts, which the Company believes is the best estimate of fair value. At September 30, 2011, the Company’s open reverse repurchase agreements had remaining terms that ranged from 5 to 234 days and had interest rates ranging from 0.23% to 2.40%. At September 30, 2011, approximately 70% of open reverse repurchase agreements were with four counterparties. At December 31, 2010, the Company’s open reverse repurchase agreements had remaining terms that ranged from 13 to 178 days and had interest rates ranging from 0.27% to 2.60%. At December 31, 2010, approximately 77% of open reverse repurchase agreements were with four counterparties.

The Company follows the provisions of ASC 860-20, Sales of Financial Assets, which requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously or in contemplation of the initial transfer to be evaluated as a linked transaction unless certain criteria are met, including that the transferred asset must be readily obtainable in the marketplace. As of September 30, 2011 and December 31, 2010, the Company did not have any material seller financing. No transactions are accounted for as linked transactions at September 30, 2011 and December 31, 2010.

(H) Purchased Options: The Company has entered into options primarily to help mitigate overall market risk. When the Company purchases an option, an amount equal to the premium paid is recorded as an asset and is subsequently marked-to-market. Premiums paid for purchasing options that expire unexercised are recognized on the expiration date as realized losses. If an option is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company enters into a closing transaction, the Company will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premiums paid. The Company had no purchased options outstanding as of September 30, 2011 and December 31, 2010.

(I) When-Issued/Delayed Delivery Securities: The Company may purchase or sell securities on a when-issued or delayed delivery basis. Securities purchased or sold on a when-issued basis are traded for delivery beyond the normal settlement date at a stated price or yield, and no income accrues to the purchaser prior to settlement. Purchasing or selling securities on a when-issued or delayed delivery basis involves the risk that the market price or yield at the time of settlement may be lower or higher than the agreed-upon price or yield, in which case a realized loss may be incurred.

The Company transacts in the forward settling To Be Announced MBS (“TBA”) market. The Company typically does not take delivery of TBAs, but rather settles with its trading counterparties on a net basis. The market value of the securities that the Company is required to purchase pursuant to a TBA transaction may decline below the agreed-upon purchase price. Conversely, the market value of the securities that the Company is required to sell pursuant to a TBA transaction may increase above the agreed upon sale price. As part of its TBA activities, the Company may “roll” its TBA positions, whereby the Company may sell (buy) securities for delivery (receipt) in an earlier month and simultaneously contract to repurchase (sell) similar, but not identical, securities at an agreed-upon price on a fixed date in a later month (with the later-month price typically lower than the earlier- month price). The Company accounts for its TBA transactions (including those related to TBA rolls) as purchases and sales. As of September 30, 2011, total assets included $53.0 million of TBAs as well as $545.5 million of receivable for securities sold relating to unsettled TBA sales. As of December 31, 2010, total assets included $54.4 million of TBAs as well as $753.0 million of receivable for securities sold relating to unsettled TBA sales.

As of September 30, 2011, total liabilities included $544.8 million of TBAs sold short as well as $53.3 million of payable for securities purchased relating to unsettled TBA purchases. As of December 31, 2010, total liabilities included $749.7 million of TBAs sold short as well as $54.7 million of payable for securities purchased relating to unsettled TBA purchases. On a net basis, as of September 30, 2011, the Company held a net short position in TBAs of $491.8 million while at December 31, 2010, the Company held a net short position in TBAs of $695.3 million.

(J) Offering Costs/Placement Fees: Offering costs and placement fees are charged against shareholders’ equity. Costs associated with the Company’s public offering of common shares, which closed on October 14, 2010, were offset against the proceeds of the offering and charged against shareholders’ equity as of December 31, 2010.

(K) LTIP Units: Long term incentive plan units (“LTIP units”) have been issued to the Company’s dedicated officers, independent directors as well as the Manager. Costs associated with LTIP units issued to dedicated officers and independent directors are amortized over the vesting period in accordance with ASC 718-10, Compensation—Stock Compensation. Costs associated with LTIP units issued to the Manager are amortized over the vesting period in accordance with ASC 505-50, Equity-Based Payments to Non-Employees. The vesting period for units issued to officers and independent directors under the Ellington Incentive Plan for Individuals (the “Individual LTIP”) is typically one year. The vesting period for units issued to the Manager under the Ellington Incentive Plan for Entities (the “Manager LTIP”) occurred over a three year period that ended in August 2010. The cost of the Manager LTIP units fluctuated with the price per share until the vesting date, whereas the cost of the Individual LTIP units is based on the price per share at the initial grant date.

(L) Dividends: Dividends payable are recorded in the consolidated financial statements on the ex-dividend date.

(M) Shares Repurchased: Common shares that are repurchased by the Company subsequent to issuance decrease total number of shares outstanding and issued.

(N) Earnings Per Share (“EPS”): Basic EPS is computed using the two class method by dividing net increase (decrease) in shareholders’ equity resulting from operations after adjusting for the impact of long term incentive plan units deemed to be participating securities, by the weighted average number of common shares outstanding calculated excluding long term incentive units. Because the Company’s long term incentive plan units are deemed to be participating securities and the Company has no other equity securities outstanding, basic and diluted EPS are the same. See Note 8 for EPS computations.

(O) Income Taxes: The Company intends to be treated as a partnership for U.S. federal income tax purposes. In general, partnerships are not subject to entity-level tax on their income, but the income of a partnership is taxable to its owners on a flow-through basis.

The Company follows the provisions of ASC 740-10, Income Taxes (“ASC 740-10”), which requires management to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement which could result in the Company recording a tax liability that would reduce shareholders’ equity. The Company did not have any additions to its unrecognized tax benefits resulting from tax positions related either to the current period or to 2010, 2009, 2008 or 2007 (its open tax years), and no reductions resulting from tax positions of prior years or due to settlements, and thus had no unrecognized tax benefits since inception. The Company does not expect any change in unrecognized tax benefits within the next fiscal year.

The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any such positions, the Company might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management’s conclusions regarding ASC 740-10 may be subject to review and adjustment at a later date based on factors including, but not limited to, further implementation guidance from the Financial Accounting Standards Board (“FASB”), and ongoing analyses of tax laws, regulations and interpretations thereof.

(P) Subsequent Events: The Company applies the provisions of ASC 855-10, Subsequent Events, in the preparation of its consolidated financial statements. This standard establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued.

(Q) Recent Accounting Pronouncements: On May 12, 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. generally accepted accounting principles (“U.S. GAAP”) and International Financial Reporting Standards (“IFRS”) (“ASU 2011-04”). This ASU represents the completion of the joint project on fair value of the FASB and International Accounting Standards Board (“IASB”). The objective of the project was to bring together as closely as possible the fair value measurement and disclosure guidance issued by the two boards. Many of the changes in the U.S. final standard represent clarifications to existing guidance. The standard also includes new required quantitative disclosures about unobservable inputs for all Level 3 fair value measurements, as well as qualitative disclosures about the sensitivity inherent in recurring Level 3 fair value measurements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The Company is evaluating the impact of the adoption of ASU 2011-04.

On April 29, 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing—(Topic 860), Reconsideration of Effective Control for Repurchase Agreements (“ASU 2011-03”). This modifies the criteria for determining when repurchase agreements and other similar transactions would be accounted for as financings (secured borrowings/ lending agreements) as opposed to sales (purchases) with commitments to repurchase (resell). ASU 2011-03 is effective prospectively for new transfers and existing transactions that are modified in the first interim or annual period beginning on or after December 15, 2011. The Company does not expect the adoption of ASU 2011-03 to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued ASU No. 2010-6 Fair Value Measurements and Disclosures—(Topic 820), Improving Disclosures about Fair Value Measurements (“ASU 2010-6”). This amends Subtopic 820-10 to require new disclosures for transfers in and out of Levels 1 and 2 and reporting gross activity in Level 3 fair value measurements, and clarifies the level of detail of existing disclosures. The new disclosures and clarifications are effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of reporting certain gross activity in Level 3 fair value measurements which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Adoption of ASU 2010-6 did not have a material impact on the Company’s consolidated financial statements.

3. Valuation

The following is a description of the valuation methodologies used for the Company’s financial instruments.

Level 1 valuation methodologies include the observation of quoted prices (unadjusted) for identical assets or liabilities in active markets, often received from widely recognized data providers.

Level 2 valuation methodologies include the observation of (i) quoted prices for similar assets or liabilities in active markets, (ii) inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves) in active markets and (iii) quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3 valuation methodologies include (i) the use of proprietary models that require the use of a significant amount of judgment and the application of various assumptions including, but not limited to, prepayment and default rate assumptions, and (ii) the solicitation of valuations from third parties (typically, broker-dealers). Third-party valuation providers often utilize proprietary models that are highly subjective and also require the use of a significant amount of judgment and the application of various assumptions including, but not limited to, prepayment and default rate assumptions. The Manager utilizes such information to assign a good faith valuation (the estimated price that would be received to sell an asset or paid to transfer a liability in an orderly transaction at the valuation date) to such financial instruments. The Manager has been able to obtain third-party valuations on the vast majority of the Company’s financial instruments and expects to continue to solicit third-party valuations on substantially all of the Company’s financial instruments in the future to the extent practical.

The Manager uses its judgment based on its own models, the assessments of its portfolio managers, and third-party valuations it obtains, to determine and assign fair values to the Company’s Level 3 financial instruments. Because of the inherent uncertainty of valuation, estimated values may differ significantly from the values that would have been used had a ready market for the financial instruments existed, and the differences could be material to the consolidated financial statements.

The table below reflects the value (in thousands) of the Company’s Level 1, Level 2, and Level 3 financial instruments at September 30, 2011:


Description	Level 1		Level 2			Level 3		Total
Assets:
Investments at value-
U.S. Treasury and Agency residential mortgage-backed securities	$	—	$	881,372		$	5,461	$	886,833
Private label residential mortgage-backed securities		—		—			396,264		396,264
Private label commercial mortgage-backed securities		—		—			14,879		14,879
Commercial Mortgage Loans		—		—			4,375		4,375

Total investments at value		—		881,372			420,979		1,302,351

Financial derivatives-assets-
Credit default swaps on corporate indices		—		109			—		109
Credit default swaps on asset backed securities		—		—			59,906		59,906
Credit default swaps on asset backed indices		—		50,541			—		50,541
Total return swaps		—		827			—		827
Interest rate swaps		—		22			—		22

Total financial derivatives-assets		—		51,499			59,906		111,405

Repurchase agreements		—		18,035			—		18,035

Total investments, financial derivatives-assets and repurchase agreements	$	—	$	950,906		$	480,885	$	1,431,791


Liabilities:
Investments sold short-
U.S. Treasury and Agency residential mortgage-backed securities	$	—	$	(562,670	)	$	—	$	(562,670	)

Financial derivatives-liabilities-
Credit default swaps on asset backed indices		—		(15,467	)		—		(15,467	)
Interest rate swaps		—		(19,521	)		—		(19,521	)

Total financial derivatives-liabilities		—		(34,988	)		—		(34,988	)

Total investments sold short and financial derivatives-liabilities	$	—	$	(597,658	)	$	—	$	(597,658	)

Investments under the U.S. Treasury and Agency residential mortgage-backed securities Level 3 category are investments in Agency interest only RMBS securities. There were no transfers of financial instruments between Level 1, Level 2, or Level 3 during the nine month period ended September 30, 2011.

The table below reflects the value (in thousands) of the Company’s Level 1, Level 2, and Level 3 financial instruments at December 31, 2010:


Description	Level 1			Level 2			Level 3		Total
Assets:
Investments at value-
U.S. Treasury and Agency residential mortgage-backed securities	$	—		$	905,378		$	—	$	905,378
Private label residential mortgage-backed securities		—			—			338,839		338,839
Private label commercial mortgage-backed securities		—			—			1,850		1,850

Total investments at value		—			905,378			340,689		1,246,067

Financial derivatives-assets-
Credit default swaps on asset backed securities		—			—			102,850		102,850
Credit default swaps on asset backed indices		—			96,690			—		96,690
Interest rate swaps		—			1,795			—		1,795

Total financial derivatives-assets		—			98,485			102,850		201,335

Repurchase agreements		—			25,684			—		25,684

Total investments, financial derivatives-assets and repurchase agreements	$	—		$	1,029,547		$	443,539	$	1,473,086


Liabilities:
Investments sold short-
U.S. Treasury and Agency residential mortgage-backed securities	$	—		$	(775,145	)	$	—	$	(775,145	)

Financial derivatives-liabilities-
Credit default swaps on corporate indices		—			(186	)		—		(186	)
Credit default swaps on asset backed indices		—			(18,278	)		—		(18,278	)
Interest rate swaps		—			(1,676	)		—		(1,676	)
Unrealized depreciation on futures contracts		(890	)		—			—		(890	)

Total financial derivatives-liabilities		(890	)		(20,140	)		—		(21,030	)

Total investments sold short and financial derivatives-liabilities	$	(890	)	$	(795,285	)	$	—	$	(796,175	)

There were no transfers of financial instruments between Level 1, Level 2, or Level 3 during the year ended December 31, 2010.

At December 31, 2010, the Company held money market investments that are included in cash and cash equivalents on the Consolidated Statement of Assets, Liabilities and Shareholders’ Equity and are considered Level 1 financial instruments.

The tables below include a roll-forward of the Company’s financial instruments for the three month periods ended September 30, 2011 and 2010, respectively (including the change in fair value), for financial instruments classified by the Company within Level 3 of the valuation hierarchy.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended September 30, 2011


(In thousands)	Beginning Balance as of June 30, 2011		Accreted Discounts / Amortized Premiums			Realized Gain/(Loss)			Change in Net Unrealized Gain/(Loss)			Purchases		Sales			Transfers In and/or Out of Level 3		Ending Balance as of September 30, 2011
Assets:
Investments at value-
U.S. Treasury and Agency residential mortgage-backed securities	$	5,227	$	(423	)	$	—		$	(2,169	)	$	2,826	$	—		$	—	$	5,461
Private label residential mortgage-backed securities		357,894		4,389			3,107			(12,994	)		106,262		(62,394	)		—		396,264
Private label commercial mortgage-backed securities		10,942		147			(38	)		(1,707	)		6,918		(1,383	)		—		14,879
Commercial Mortgage Loans		4,650		31			—			(306	)		—		—			—		4,375

Total investments at value		378,713		4,144			3,069			(17,176	)		116,006		(63,777	)		—		420,979


Financial derivatives- assets
Credit default swaps on asset backed securities		69,829		—			3,088			(248	)		122		(12,885	)		—		59,906

Total financial derivatives- assets		69,829		—			3,088			(248	)		122		(12,885	)		—		59,906

Total investments and financial derivatives-assets	$	448,542	$	4,144		$	6,157		$	(17,424	)	$	116,128	$	(76,662	)	$	—	$	480,885

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at September 30, 2011, as well as Level 3 financial instruments disposed of by the Company during the three month period ended September 30, 2011. For Level 3 financial instruments held by the Company at September 30, 2011, change in net unrealized gain (loss) of $(15.9) million and $2.3 million, for the three month period ended September 30, 2011 relate to investments and financial derivative-assets, respectively.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended September 30, 2010


(In thousands)	Beginning Balance as of June 30, 2010		Accreted Discounts / Amortized Premiums		Realized Gain/(Loss)			Change in Net Unrealized Gain/(Loss)			Purchases		Sales			Transfers In and/or Out of Level 3		Ending Balance as of September 30, 2010
Assets:
Investments at value-
Private label residential mortgage-backed securities	$	245,519	$	2,783	$	2,511		$	22,016		$	33,859	$	(36,800	)	$	—	$	269,888

Total investments at value		245,519		2,783		2,511			22,016			33,859		(36,800	)		—		269,888

Financial derivatives- assets
Credit default swaps on asset backed securities		113,425		—		(2,683	)		(1,647	)		422		(6,943	)		—		102,574

Total financial derivatives- assets		113,425		—		(2,683	)		(1,647	)		422		(6,943	)		—		102,574

Total investments and financial derivatives-assets	$	358,944	$	2,783	$	(172	)	$	20,369		$	34,281	$	(43,743	)	$	—	$	372,462

In January 2010, the FASB issued ASU No. 2010-6 Fair Value Measurements and Disclosures—(Topic 820), Improving Disclosures about Fair Value Measurements, which became effective for fiscal years beginning after December 15, 2010. As a result certain classifications in the above table have been conformed to the current period presentation.

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at September 30, 2010, as well as Level 3 financial instruments disposed of by the Company during the three month-period ended September 30, 2010. For Level 3 financial instruments held by the Company at September 30, 2010, change in net unrealized gain (loss) of $18.9 million and $(1.6) million for the three month period ended September 30, 2010 relate to investments and financial derivative-assets, respectively.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Nine Month Period Ended September 30, 2011


(In thousands)	Beginning Balance as of December 31, 2010		Accreted Discounts / Amortized Premiums			Realized Gain/(Loss)		Change in Net Unrealized Gain/(Loss)			Purchases		Sales			Transfers In and/or Out of Level 3		Ending Balance as of September 30, 2011
Assets:
Investments at value-
U.S. Treasury and Agency residential mortgage-backed securities	$	—	$	(843	)	$	97	$	(2,320	)	$	9,682	$	(1,155	)	$	—	$	5,461
Private label residential mortgage-backed securities		338,839		11,710			17,664		(35,632	)		292,521		(228,838	)		—		396,264
Private label commercial mortgage-backed securities		1,850		378			859		(3,185	)		23,669		(8,692	)		—		14,879
Commercial Mortgage Loans		—		92			—		(392	)		4,675		—			—		4,375

Total investments at value		340,689		11,337			18,620		(41,529	)		330,547		(238,685	)		—		420,979


Financial derivatives- assets
Credit default swaps on asset backed securities		102,851		—			8,396		(4,987	)		525		(46,879	)		—		59,906

Total financial derivatives- assets		102,851		—			8,396		(4,987	)		525		(46,879	)		—		59,906

Total investments and financial derivatives-assets	$	443,540	$	11,337		$	27,016	$	(46,516	)	$	331,072	$	(285,564	)	$	—	$	480,885

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at September 30, 2011, as well as Level 3 financial instruments disposed of by the Company during the nine month period ended September 30, 2011. For Level 3 financial instruments held by the Company at September 30, 2011, change in net unrealized gain (loss) of $(32.2) million and $(12.6) million for the nine month period ended September 30, 2011 relate to investments and financial derivative-assets, respectively.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Nine Month Period Ended September 30, 2010


(In thousands)	Beginning Balance as of December 31, 2009			Accreted Discounts / Amortized Premiums		Realized Gain/(Loss)			Change in Net Unrealized Gain/(Loss)			Purchases		Sales			Transfers In and/or Out of Level 3		Ending Balance as of September 30, 2010
Assets:
Investments at value-
Private label residential mortgage-backed securities	$	210,364		$	8,722	$	14,411		$	26,360		$	192,085	$	(182,054	)	$	—	$	269,888

Total investments at value		210,364			8,722		14,411			26,360			192,085		(182,054	)		—		269,888

Financial derivatives- assets
Credit default swaps on corporate bonds		8,476			—		(2,281	)		(2,650	)		1,713		(5,258	)		—		—
Credit default swaps on asset backed securities		95,199			—		8,787			(16,802	)		38,535		(23,145	)		—		102,574
Other swaps		257			—		335			(257	)		—		(335	)		—		—

Total financial derivatives- assets		103,932			—		6,841			(19,709	)		40,248		(28,738	)		—		102,574

Total investments and financial derivatives-assets	$	314,296		$	8,722	$	21,252		$	6,651		$	232,333	$	(210,792	)	$	—	$	372,462

Liabilities:
Financial derivatives- liabilities
Credit default swaps on asset backed securities	$	(10,548	)	$	—	$	(1,658	)	$	3,881		$	8,340	$	(15	)	$	—	$	—

Total financial derivatives- liabilities	$	(10,548	)	$	—	$	(1,658	)	$	3,881		$	8,340	$	(15	)	$	—	$	—

Total investments sold short and financial derivatives- liabilities	$	(10,548	)	$	—	$	(1,658	)	$	3,881		$	8,340	$	(15	)	$	—	$	—

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at September 30, 2010, as well as Level 3 financial instruments disposed of by the Company during the nine month-period ended September 30, 2010. For Level 3 financial instruments held by the Company at September 30, 2010, change in net unrealized gain (loss) of $22.1 million and $(18.1) million for the nine month period ended September 30, 2010 relate to investments and financial derivative-assets, respectively.

4. Financial Derivatives

Gains and losses on the Company’s derivative contracts for the three and nine month periods ended September 30, 2011 are summarized in the tables below (in thousands):

September 30, 2011:


Derivative Type	Primary Risk Exposure	Net Realized Gain/(Loss) for the Three Month Period Ended September 30, 2011			Change in Net Unrealized Gain/(Loss) for the Three Month Period Ended September 30, 2011			Net Realized Gain/(Loss) for the Nine Month Period Ended September 30, 2011			Change in Net Unrealized Gain/(Loss) for the Nine Month Period Ended September 30, 2011
Financial derivatives - assets
Credit Default Swaps on Asset Backed Securities	Credit	$	3,088		$	(248	)	$	8,396		$	(4,987	)
Credit Default Swaps on Asset Backed Indices	Credit		6,539			3,746			5,313			5,719
Credit Default Swaps on Corporate Bond Indices	Credit		(150	)		109			(150	)		109
Total Return Swaps	Equity Market		(29	)		826			(29	)		826
Interest Rate Swaps	Interest Rates		456			(938	)		(195	)		(1,773	)

			9,904			3,495			13,335			(106	)

Financial derivatives - liabilities
Credit Default Swaps on Asset Backed Indices	Credit		24			(1,038	)		8,886			(1,256	)
Credit Default Swaps on Corporate Bond Indices	Credit		100			220			—			186
Interest Rate Swaps	Interest Rates		(3,249	)		(14,154	)		(4,250	)		(17,844	)

			(3,125	)		(14,972	)		4,636			(18,914	)

Futures contracts
Short Eurodollar contracts	Interest Rates		(375	)		369			(1,094	)		890

Total		$	6,404		$	(11,108	)	$	16,877		$	(18,130	)

Gains and losses on the Company’s derivative contracts for the three and nine month periods ended September 30, 2010 are summarized in the tables below (in thousands):

September 30, 2010:


Derivative Type	Primary Risk Exposure		Net Realized Gain/(Loss) for the Three Month Period Ended September 30, 2010			Change in Net Unrealized Gain/(Loss) for the Three Month Period Ended September 30, 2010			Net Realized Gain/(Loss) for the Nine Month Period Ended September 30, 2010			Change in Net Unrealized Gain/(Loss) for the Nine Month Period Ended September 30, 2010
Financial derivatives - assets
Credit Default Swaps on Asset Backed Securities		Credit	$	(2,683	)	$	(1,647	)	$	8,787		$	(16,802	)
Credit Default Swaps on Asset Backed Indices		Credit		(892	)		(723	)		(5,184	)		934
Credit Default Swaps on Corporate Bond Indices		Credit		(50	)		(166	)		(48	)		(168	)
Credit Default Swaps on Corporate Bonds		Credit		—			—			(2,281	)		(2,650	)
Other Swaps		Credit		—			—			335			(257	)
Interest Rate Swaps		Interest Rates		125			—			—			(109	)

				(3,500	)		(2,536	)		1,609			(19,052	)

Financial derivatives - liabilities
Credit Default Swaps on Asset Backed Securities		Credit		—			—			(1,658	)		3,881
Credit Default Swaps on Asset Backed Indices		Credit		(243	)		38			6,281			(228	)
Credit Default Swaps on Corporate Bond Indices		Credit		—			—			(1,003	)		1,146
Total Return Swaps		Equity Market		—			—			(854	)		88
Interest Rate Swaps		Interest Rates		(125	)		(1,850	)		(1,023	)		(3,064	)

				(368	)		(1,812	)		1,743			1,823

Futures contracts
Short Eurodollar contracts		Interest Rates		(581	)		(579	)		(1,607	)		(1,928	)

Total			$	(4,449	)	$	(4,927	)	$	1,745		$	(19,157	)

As of September 30, 2011, the Company is party to credit derivatives contracts in the form of credit default swaps on mortgage/asset backed securities and indices, or “ABSCDS.” As a seller of credit protection via ABSCDS, the Company receives periodic payments from protection buyers, and is obligated to make payments to the protection buyer upon the occurrence of a “credit event” with respect to underlying reference assets. Written credit derivatives held by the Company at September 30, 2011 and December 31, 2010, respectively, are summarized below (in thousands):


Single Name and Index Credit Default Swaps (Asset Backed Securities)	Amount at September 30, 2011			Amount at December 31, 2010
Fair Value of Written Credit Derivatives, Net	$	(15,467	)	$	(14,375	)
Fair Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties⁽¹⁾	$	5,806		$	18,286
Notional Amount of Written Credit Derivatives⁽²⁾	$	(26,907	)	$	(111,717	)
Notional Amount of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties⁽¹⁾	$	13,107		$	43,721

⁽¹⁾	Offsetting transactions with third parties include purchased credit derivatives which have the same reference obligation.

⁽²⁾

The notional amount is the maximum amount that a seller of ABSCDS would be obligated to pay, and a buyer of credit protection would receive upon occurrence of a “credit event.” Movements in the value of credit default swap transactions may require the Company or the counterparty to post or receive collateral. Amounts due or owed under an ABSCDS contract may be offset against amounts due or owed on other ABSCDS contracts with the same ISDA counterparty.

Unless terminated by mutual agreement by both the buyer and seller, ABSCDS contracts typically terminate at the earlier of the (i) date the buyer of protection delivers the reference asset to the seller in exchange for payment of the notional balance following the occurrence of a credit event or (ii) date the reference asset is paid off in full, retired, or otherwise ceases to exist. Implied credit spreads may be used to determine the market value of swap contracts and are reflective of the cost of buying/selling protection. Higher spreads would indicate a greater likelihood that a seller will be obligated to perform (i.e., make payment) under the swap contract. In situations where the credit quality of an underlying reference asset has deteriorated, credit spreads combined with a percentage of notional amounts paid up front (points up front) are frequently used as an indication of ABSCDS risk. ABSCDS credit protection sellers entering the market would expect to be paid a percentage of the current notional balance up front (points up front) approximately equal to the fair value of the contract in order to write protection on the reference assets underlying the Company’s ABSCDS contracts. Stated spreads at September 30, 2011 on ABSCDS contracts where the Company wrote protection range between 9 and 350 basis points on contracts that were outstanding at this date. Stated spreads at December 31, 2010 on ABSCDS contracts where the Company wrote protection range between 9 and 442 basis points on contracts that were outstanding at this date. However, participants entering the market at September 30, 2011 and December 31, 2010 would likely transact on similar contracts with material points upfront given these spreads. Total net up-front payments received relating to ABSCDS contracts outstanding at September 30, 2011 and December 31, 2010 were $13.8 million and $13.5 million, respectively.

5. Base Management Fee and Incentive Fee

The Company has engaged the Manager to manage the assets, operations and affairs of the Company and pays various management fees associated with that arrangement. Effective August 2, 2011, the Board of Directors approved a Third Amended and Restated Management Agreement between the Company and the Manager. The Base Management Fees and Incentive Fees payable under the agreement are detailed below.

Base Management Fees

The Manager receives an annual base management fee in an amount equal to 1.50% per annum of the Company’s shareholders’ equity as of the end of each fiscal quarter (before deductions for base management fees and incentive fees payable with respect to such fiscal quarter). The base management fee is payable quarterly in arrears.

Summary information—For the three month periods ended September 30, 2011 and 2010, the total base management fees incurred by the Company were $1.4 million and $1.2 million, respectively. For the nine month periods ended September 30, 2011 and 2010, the total base management fees incurred by the Company were $4.3 million and $3.4 million, respectively.

Incentive Fees

The Manager is entitled to receive a quarterly incentive fee equal to the positive excess of (i) the product of (A) 25% and (B) the excess of (1) Adjusted Net Income (described below) for the Incentive Calculation Period (which means such fiscal quarter and the immediately preceding three fiscal quarters) over (2) the sum of the Hurdle Amounts (described below) for the Incentive Calculation Period, over (ii) the sum of the incentive fees already paid or payable for each fiscal quarter in the Incentive Calculation Period preceding such fiscal quarter.

For purposes of calculating the incentive fee, “Adjusted Net Income” for the Incentive Calculation Period means the net increase in shareholders’ equity from operations, after all base management fees but before any incentive fees for such period, and excluding non-cash equity compensation expenses for such period as reduced by any Loss Carryforward (as described below) as of the end of the fiscal quarter preceding the Incentive Calculation Period.

For purposes of calculating the incentive fee, the “Loss Carryforward” as of the end of any fiscal quarter is calculated by determining the excess, if any, of (1) the Loss Carryforward as of the end of the immediately preceding fiscal quarter over (2) the net increase in shareholders’ equity from operations (expressed as a positive number) or net decrease in shareholders’ equity from operations (expressed as a negative number) for such fiscal quarter. As of September 30, 2011, the total Loss Carryforward was $2.4 million.

For purposes of calculating the incentive fee, the “Hurdle Amount” means, with respect to any fiscal quarter, the product of (i) one-fourth of the greater of (A) 9% and (B) 3% plus the ten-year U.S. Treasury rate for such fiscal quarter, (ii) the sum of (A) the weighted average gross proceeds per share of all our common share issuances up to the end of such fiscal quarter, with each issuance weighted by both the number of shares issued in such issuance and the number of days that such issued shares were outstanding during such fiscal quarter, using a first-in first-out basis of accounting (i.e., attributing any share repurchases to the earliest issuances first) and (B) the result obtained by dividing (I) retained earnings attributable to common shares at the beginning of such fiscal quarter by (II) the average number of common shares outstanding for each day during such fiscal quarter, and (iii) the average number of common shares and LTIP units outstanding for each day during such fiscal quarter. For purposes of determining the Hurdle Amount, issuances of common shares (a) as equity incentive awards, (b) to the Manager as part of its base management fee or incentive fee and (c) to the Manager or any of its affiliates in privately negotiated transactions, are excluded from the calculation. The payment of the incentive fee will be in a combination of common shares and cash, provided that at least 10% of any quarterly payment will be made in common shares.

Summary information— No incentive fee was incurred for the three month period ended September 30, 2011. Total incentive fee incurred for the three month period ended September 30, 2010 was $2.5 million. Total incentive fee incurred for the nine month periods ended September 30, 2011 and 2010, were $0.6 million and $3.0 million, respectively.

6. Long-Term Incentive Plan Units

In connection with its initial offering in 2007, the Company established the Manager Long-Term Incentive Plan (the “Manager LTIP”) and the Individual Long-Term Incentive Plan (the “Individual LTIP”). Pursuant to the terms of the Manager LTIP, the Company issued 375,000 long-term incentive plan units to its Manager. Pursuant to the terms of the Individual LTIP, each year since inception the Company has issued annual awards to its independent directors and, beginning in 2010, issued awards to certain of its officers.

As of August 17, 2010, LTIP units awarded to the Manager were fully vested and fully expensed. LTIP units held pursuant to the Manager LTIP are generally exercisable by the holder at any time after vesting. Each LTIP unit is convertible into one common share. During the three month period ended September 30, 2010, expense recognized related to the Manager LTIP was approximately $0.4 million and during the nine month period ended September 30, 2010, expense recognized related to the Manager LTIP was approximately $1.9 million. There is no cash flow effect from the issuance of the Manager LTIP units. Since inception, the aggregate expense associated with the Manager LTIP was $8.6 million.

Individual LTIP units in the amount of 3,750 units were granted to the Company’s independent directors on each of August 17, 2007, December 31, 2008, October 1, 2009, October 1, 2010 and September 15, 2011. Excluding the October 1, 2010 and September 15, 2011 awards, these grants have fully vested. The vesting period for awards issued to directors under the Individual LTIP has generally been one year from the date of grant. In addition, on December 15, 2010, the Company issued a total of 2,500

LTIP units to certain of its dedicated officers. The vesting period for this grant is also one year from the date of grant. LTIP units held pursuant to the Individual LTIP are generally exercisable by the holder at any time after vesting. Each LTIP unit is convertible into one common share. Costs associated with the Individual LTIP are measured as of the grant date and expensed ratably over the vesting period. The total expenses associated with the Individual LTIP units awarded to the independent directors for the three month periods ended September 30, 2011 and 2010, were $0.03 million and $0.02 million, respectively. The total expenses associated with the Individual LTIP units awarded to the independent directors for the nine month periods ended September 30, 2011 and 2010, were $0.08 million and $0.07 million, respectively. The total expense associated with the Individual LTIP units awarded to the Company’s dedicated officers for the three month period ended September 30, 2011 was approximately $0.01 million and the total expense associated with the Individual LTIP units awarded to the Company’s dedicated officers for the nine month period ended September 30, 2011 was approximately $0.04 million. Unrecognized expense related to unvested Individual LTIP units awarded to independent directors was $0.06 million at September 30, 2011 and $0.07 million at December 31, 2010. Unrecognized expense related to unvested Individual LTIP units awarded to certain of the Company’s dedicated officers was $0.01 millions at September 30, 2011 and $0.05 million at December 31, 2010. Since inception, 7,500 common shares were issued in connection with the conversion of Individual LTIP units awarded to independent directors at the direction of the three award holders and $0.2 million was transferred from the share-based LTIP awards to common shares in shareholders’ equity.

If all of the LTIP units that have previously been issued were to be fully vested and exchanged for common shares as of September 30, 2011 and December 31, 2010, the Company’s issued and outstanding common shares would increase to 16,878,631 and 16,883,342 shares, respectively, resulting in shareholders’ equity per share of $22.32 and $23.91 at September 30, 2011 and December 31, 2010, respectively.

Detailed below is a roll-forward of the Company’s LTIP units outstanding for the three month periods ended September 30, 2011 and 2010, respectively.

Three Month Periods Ended September 30, 2011 and September 30, 2010:


	Three Month Period Ended September 30, 2011						Three Month Period Ended September 30, 2010
	Manager		Director/ Employee		Total		Manager		Director/ Employee		Total
LTIP Units Outstanding (6/30/2011, 6/30/2010, respectively)		375,000		10,000		385,000		375,000		5,000		380,000
Granted		—		3,750		3,750

Large Accelerated Filer

Non-Accelerated Filer

Accelerated Filer

Smaller Reporting Company