MFA Financial, Inc. (the “Company”) was incorporated in Maryland on July 24, 1997 and began operations on April 10, 1998.  The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes.  In order to maintain its qualification as a REIT, the Company must comply with a number of requirements under federal tax law, including that it must distribute at least 90% of its annual REIT taxable income to its stockholders.  (See Note 10(b).)

On December 29, 2008, the Company filed Articles of Amendment with the State Department of Assessments and Taxation of Maryland changing its name from “MFA Mortgage Investments, Inc.” to “MFA Financial, Inc.”  The name change became effective on January 1, 2009.

The interim unaudited financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted according to such SEC rules and regulations.  Management believes, however, that the disclosures included in these interim financial statements are adequate to make the information presented not misleading.  The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31,June 30, 2009 and results of operations for all periods presented have been made.  The results of operations for the three-monthsix-month period ended March 31,June 30, 2009 should not be construed as indicative of the results to be expected for the full year.

The consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with GAAP.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  The consolidated financial statements of the Company include the accounts of all subsidiaries; significant intercompany accounts and transactions have been eliminated.

The Company’s MBS pledged as collateral against repurchase agreements and Swaps are included in investment securities on the Consolidated Balance Sheets with the fair value of the MBS pledged disclosed parenthetically.  (See Notes 3, 5, 7, 8 and 14.)

Although the Company generally intends to hold its investment securities until maturity, it may, from time to time, sell any of its securities as part of the overall management of its business.  Upon the sale of an investment security, any unrealized gain or loss is reclassified out of accumulated other comprehensive income/(loss)/income to earnings as a realized gain or loss using the specific identification method.

Interest income is accrued based on the outstanding principal balance of the investment securities and their contractual terms.  Premiums and discounts associated with Agency MBS that are issued or guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae (collectively, “Agency MBS”) and non-Agency MBS rated AA and higher at the time of purchase, are amortized into interest income over the life of such securities using the effective yield method, adjustedmethod.  Amortization and adjustments to premium amortization are made for actual prepayment activity in accordance with FAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases” (“FAS 91”).

The Company accounts for its non-Agency MBS is recognizedthat were purchased at a deep discount and/or were rated below AA at the time of purchase in accordance with Emerging Issues Task Force (“EITF”) of the FASBFinancial Accounting Standards Board (“FASB”) Consensus No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”), as amended by FSPFASB Staff Position (“FSP”) No. EITF 99-20-1 “Amendments to the Impairment Guidance of EITF 99-20” (“FSP EITF(collectively, “EITF 99-20-1”).  Pursuant toUnder EITF 99-20, cash flows from a security are estimated based on the holder’s best estimate of current information and events and the excess of the future cash flows over the investment is recognized as interest income under the effective yield method.

Cash and cash equivalents include cash on deposit with financial institutions and investments in high quality overnight money market funds, all of which have original maturities of three months or less.  Cash and cash equivalents may also include cash pledged as collateral to the Company by its repurchase agreement and/or Swap counterparties as a result of reverse margin calls.calls (i.e., margin calls made by the Company).  The Company did not hold any cash pledged by its counterparties at June 30, 2009 and held $10.0 million and $5.5 million of cash pledged by its counterparties at March 31, 2009 and December 31, 2008, respectively.2008.  At March 31,June 30, 2009, all of the Company’s cash investments were in high quality overnight money market funds, such that their carrying amount is deemed to be their fair value.funds.  (See Note 8.)

Restricted cash represents the Company’s cash held by counterparties as collateral against the Company’s Swaps and/or repurchase agreements.  Restricted cash, which earns interest, is not available to the Company for general corporate purposes, but may be applied against amounts due to Swap or repurchase agreement counterparties or returned to the Company when the collateral requirements are exceeded or at the maturity of the Swap or repurchase agreement.  The Company had restricted cash, held as collateral against its repurchase agreements and Swaps of $78.8$39.9 million and $70.7 million at March 31,June 30, 2009 and December 31, 2008, respectively.  (See Notes 5 7 and 8.)

The Company accounts for its goodwill in accordance with FAS No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”) which provides, among other things, how entities are to account for goodwill and other intangible assets that arise from business combinations or are otherwise acquired.  FAS 142 requires that goodwill be tested for impairment annually or more frequently under certain circumstances.  At March 31,June 30, 2009 and December 31, 2008, the Company had goodwill of $7.2 million, which represents the unamortized portion of the excess of the fair value of its common stock issued over the fair value of net assets acquired in connection with its formation in 1998.  Goodwill is tested for impairment at least annually at the entity level.  Through March 31,level and, through June 30, 2009, the Company had not recognized any impairment against its goodwill.

At March 31,June 30, 2009, the Company indirectly held 100% of the ownership interest in Lealand Place, a 191-unit apartment property located in Lawrenceville, Georgia (“Lealand”), which is consolidated with the Company.  This property was acquired through a tax-deferred exchange under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”).  (See Note 6.)

The property, capital improvements and other assets held in connection with this investment are carried at cost, net of accumulated depreciation and amortization.  Maintenance, repairs and minor improvements are expensed in the period incurred, while real estate assets, except land, and capital improvements are depreciated over their useful life using the straight-line method.

The Company finances the acquisition of a significant portion of its MBS with repurchase agreements.  Under repurchase agreements, the Company sells securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sale price.  The difference between the sale price that the Company receives and the repurchase price that the Company pays represents interest paid to the lender.  Although structured as a sale and repurchase, under its repurchase agreements, the Company pledges its securities as collateral to secure a loanthe borrowing, which is equal in value to a specified percentage of the fair value of the pledged collateral, while the Company retains beneficial ownership of the pledged collateral.  At the maturity of a repurchase agreement, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender.  With the consent of the lender, the Company may renew a repurchase agreement at the then prevailing financing terms.  Margin calls, whereby a lender requires that the Company pledge additional securities or cash as collateral to secure borrowings under its repurchase agreements with such lender, are routinely experienced by the Company as the value of the MBS pledged as collateral declines as the MBS principal is repaid, or if the fair value of the MBS pledged as collateral declines due to changes in market interest rates, spreads or other market conditions.  To date, the Company had satisfied all of its margin calls and has never sold assets to meet any margin calls.  (See Notes 7 and 8.)

The Company’s repurchase agreements typically have terms ranging from one month to three months at inception, with some having longer terms.  Should a counterparty decide not to renew a repurchase agreement at maturity, the Company must either refinance elsewhere or be in a position to satisfy the obligation.  If, during the term of a repurchase agreement, a lender should file for bankruptcy, the Company might experience difficulty recovering its pledged assets which could result in an unsecured claim against the lender for the difference between the amount loaned to the Company plus interest due to the counterparty and the fair value of the collateral pledged to such lender.  The Company generally seeks to diversify its exposure by entering into repurchase agreements with multiple counterparties with a maximum loan from any lender of no more than three times the Company’s stockholders’ equity.  At March 31,June 30, 2009, the Company had outstanding balances under repurchase agreements with 2018 separate lenders with a maximum net exposureamount at risk (the difference between the amount loaned to the Company, including interest payable, and the fair value of securities pledged by the Company as collateral, including accrued interest on such securities) to any single lender of $133.8$116.0 million, or 9.2%7.0% of stockholders’ equity, related to repurchase agreements.  (See Note 7.)

The Company accounts for its stock-based compensation in accordance with FAS No. 123R, “Share-Based Payment,” (“FAS 123R”).  The Company uses the Black-Scholes-Merton option model to value its stock options.  There are limitations inherent in this model, as with all other models currently used in the market place to value stock options.  For example, the Black-Scholes-Merton option model was not designed to value stock options which contain significant restrictions and forfeiture risks, such as those contained in the stock options that have been granted by the Company.  Significant assumptions are made in order to determine the Company’s option value, all of which are subjective.  The fair value of the Company’s stock options are expensed using the straight-line method.

Pursuant to FAS 123R, compensation expense for restricted stock awards, restricted stock units (“RSUs”) and stock options is recognized over the vesting period of such awards, based upon the fair value of such awards at the grant date.  Payments pursuant to DERs, which are attached to certain awards are charged to stockholders’ equity when declared.  Equity based awards for which there is no risk of forfeiture are expensed upon grant, or at such time that there is no longer a risk of forfeiture.  The Company applies a zero forfeiture rate for its equity based awards, given that such awards have been granted to a limited number of employees, and that historical forfeitures have been minimal.  Should information arise indicating that forfeitures may occur, the forfeiture rate would be revised and accounted for as a change in estimate.

Basic EPS is computed by dividing net income/(loss) allocable to common stockholders by the weighted average number of shares of common stock outstanding during the period, which also includes participating securities representing unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents.  Diluted EPS is computed by dividing net income available to holders of common stock by the weighted average shares of common stock and common equivalent shares outstanding during the period.  For the diluted EPS calculation, common equivalent shares outstanding includes the weighted average number of shares of common stock outstanding adjusted for the effect of dilutive unexercised stock options and RSUs outstanding using the treasury stock method.  Under the treasury stock method, common equivalent shares are calculated assuming that all dilutive common stock equivalents are exercised and the proceeds, along with future compensation expenses for unvested stock options and RSUs, are used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period.  No common share equivalents are included in the computation of any diluted per share amount for a period in which a net operating loss is reported.

The Company’s adoption of FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“EITF 03-6-1”) on January 1, 2009 did not have a material impact on the Company’s EPS for current or prior periods.historical EPS.  (See Notes 2(o)2(n) and 11.)

The Company’s comprehensive income/(loss) includes net income/(loss), the change in net unrealized gains/(losses) on its investment securities and hedging instruments, adjusted by realized net gains/(losses) included in net income/(loss) for the period and is reduced by dividends declared on the Company’s preferred stock.

The Company has elected to be taxed as a REIT under the provisions of the Code and the corresponding provisions of state law.  The Company expects to operate in a manner that will enable it to continue to be taxed as a REIT.  A REIT is not subject to tax on its earnings to the extent that it distributes its REIT taxable income to its stockholders.  As such, no provision for current or deferred income taxes has been made in the accompanying consolidated financial statements.

The Company utilizes derivative financial instruments to manageAs part of the Company’s interest rate risk management process, it periodically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts.  The Company’s derivatives are entirely comprised of Swaps, which have the effect of modifying the interest rate repricing characteristics of the Company’s repurchase agreements and cash flows for such liabilities.  The Company does not enter into derivative transactions for speculative or trading purposes.  These derivative financial instruments were comprised ofThe Company accounts for its Swaps for the periods presented and are accounted for in accordance with FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“FAS 133”).  The Company’s Swaps are designated as cash flow hedges against the benchmark interest rate risk associated with its borrowings.  No cost is incurred at the inception of a Swap, under which the Company agrees to pay a fixed rate of interest and receive a variable interest rate, generally based on one-month or three-month London Interbank Offered Rate (“LIBOR”), on the notional amount of the Swap.  The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities, and upon entering into hedging transactions, documents the relationship between the hedging instrument and the hedged liability.  The Company assesses, both at inception of a hedge and on an on-goinga quarterly basis thereafter, whether or not the hedge is “highly effective,” in accordance with FAS 133.

The Company discontinues hedge accounting on a prospective basis and recognizes changes in the fair value through earnings when:  (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (including forecasted transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the derivative as a hedge is no longer appropriate.

Swaps are carried on the Company’s balance sheet at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative.  Since the Company’s Swaps are designated as “cash flow hedges,” changes in their fair value is recorded in other comprehensive income/(loss)/income provided that the hedge isremains effective.  A change in fair value for any ineffective amount of the Company’s Swaps would be recognized in earnings.  The Company has not recognized any change in the value of its existing Swaps through earnings as a result of ineffectiveness of the hedge, except that the Company has recognized 100% of all gains and losses realized on Swaps that have beenwere terminated early, as all of the associated hedges were deemed ineffective.  (See Notes 5, 8 and 14.)

FASB Interpretation (“FIN”) No. 39-1, “Amendment of FIN No. 39” (“FIN 39-1”), defines “right of setoff” and specifies the conditions that must be met for a derivative contract to qualify for this right of setoff.  FIN 39-1 also addresses the applicability of a right of setoff to derivative instruments and clarifies the circumstances in which it is appropriate to offset amounts recognized for those instruments in the balance sheet.  In addition, FIN 39-1 permits offsetting of fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from the same master netting arrangement as the derivative instruments.  The Company’s adoption of FIN 39-1 on January 1, 2008 did not have any impact on its consolidated financial statements, as the Company does not offset cash collateral receivables or payables against its net derivative positions.  (See Notes 5, 8 and 14.)

On January 1, 2008,The Company applies the Company adoptedprovisions of FAS No. 157, “Fair Value Measurements” (“FAS 157”), which defines fair value, establishesprovides a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements.  Changes to previous practice resulting from the application of FAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expandedsets forth certain disclosures about fair value measurements.  FAS 157 clarifiedstipulates that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability.  The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability.  FAS 157 provides a consistent definition of fair value which focuses on exit price and prioritizes, the use of market-based inputs over entity-specific inputs when determining fair value.  In addition, FAS 157 provides a framework for measuring fair value, and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.  (See Notes 2(p)2(n) and 14.)

In October 10, 2008, the FASB issued FSP No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”).  FSP 157-3 clarifies the application of FAS 157 in a market that is not active and provides an example to illustrate key consideration in determining the fair value of a financial asset when the market for that financial asset is not active.  The issuance of FSP 157-3 did not have anya material impact on the Company’s determination of fair value for its financial assets.

FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS 159”), permits entities to elect to measure many financial instruments and certain other items at fair value.  Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date.  A decision to elect the fair value option for an eligible financial instrument, which may be made on an instrument by instrument basis, is irrevocable.  The adoption of FAS 159 on January 1, 2008 did not have any impact on the Company’s consolidated financial statements, as it did not elect the fair value option onfor any of its assets or liabilities.

On January 1, 2009, the Company adopted FSP No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP 140-3”), which provides guidance on accounting for transfers of financial assets and repurchase financings.  FSP 140-3 presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (i.e., a linked transaction) under FAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”).  However, if certain criteria are met, as described in FSP 140-3, are met, the initial transfer and repurchase financing shall not be evaluated as a linked transaction and shall be evaluated separately under FAS 140.  If the linked transaction does not meet the requirements for sale accounting, the linked transaction shall generally be accounted for as a forward contract, as opposed to the current presentation, where the purchased asset and the repurchase liability are reflected separately on the balance sheet.  The adoption of FSP 140-3 had no impact on the Company’s consolidated financial statements, as the Company didhas not enterentered into any linked transactions.

On January 1, 2009, the Company adopted EITF 03-6-1, which provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of basic earnings per share pursuant to the two-class method.  EITF 03-6-1 requires that all previously reported EPS data is retrospectively adjusted to conform with the provisions of EITF 03-6-1.  The Company’s adoption of EITF 03-6-1 on January 1, 2009 did not have a material impact on the Company’s historical or current period EPS amounts.

OnIn April 9, 2009, the FASB issued three Staff Positions, that were required to be adopted concurrently, which included: (i) FSP No. FAS 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1 and APB 28-1”), FSP115-2, (ii) Staff Position No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for thean Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”Orderly,” (“FSP FAS 157-4”), and FSP(iii) Staff Position No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2 and 124-2”).  The key provisions of these FSPs, which are intended to provide additional guidance for interim fair value disclosures, fair value measurements and the determination of other-than-temporary impairments, are summarized as follows:

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

At March 31,June 30, 2009 and December 31, 2008, the Company’s investment securities portfolio consisted primarily of poolsMBS secured by hybrid mortgages that have a fixed interest rate for a specified period, typically three to ten years, and, thereafter, generally reset annually (“Hybrids”), and adjustable-rate mortgages (“ARMs”) (collectively, “ARM-MBS”).  The Company’s ARM-MBS are primarily comprised of Agency ARM-MBS.  The Company’sMBS and, to a lesser extent, non-Agency MBS, 99.9% ofMBS.  In addition, the Company may have investments in other mortgage-related securities and other investments, which were comprised of Senior MBS, are reported below based on the lowest rating issued by a Rating Agency at the date presented.may or may not be rated.  The Company may pledge its MBS as collateral against its repurchase agreements and Swaps.  (See Note 8.)  The following tables present certain information about the Company's investment securities at March 31, 2009 and December 31, 2008:

Certain ofThe following table presents certain information about the Company’s non-Agency MBS were purchasedCompany's investment securities at a discount to par value.  The portion of such discount that is considered credit protection against future credit losses is designated as a credit reserve and is not accreted into interest income.  Discounts designated as credit reserves may be adjusted over time, based on review of the investment or, if applicable, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors.  If the performance of these securities is more favorable than forecasted, a portion of the discount initially designated as a credit reserve may be accreted into interest income over time.  Conversely, if the performance of these securities is less favorable than forecasted, other-than-temporary impairment charges and write-downs of such securities to a new cost basis could result.  The Company had unearned discounts of $73.4 million, of which $38.8 million were designated as credit reserves, at March 31,June 30, 2009 and $15.0 million, of which $5.9 million were designated as credit reserves, at December 31, 2008.2008:

The following table presents information about the Company’s investment securities that were in an unrealized loss position at March 31,June 30, 2009:

During the three months ended March 31,June 30, 2009, the Company recognized aggregate other-than-temporary impairments of $1.5 million against five of its non-Agencysold 20 Agency MBS none of which were Senior MBS.  These non-Agency MBS hadwith an amortized cost of $1.7$425.0 million, priorrealizing gross gains of $13.5 million.  These securities were sold to recognizing the impairments and, an aggregate carrying value of $218,000 after recognizing the other-than-temporary impairments.  All ofdecrease the Company’s remaining MBS, including MBS that wereexposure to potential increases in an unrealized loss position, were performinginterest rates in accordance with their terms.future years.  During the three months ended March 31, 2008, the Company recognized an impairment charge $851,000 against an unrated investment security, which had an amortized cost of $1.9 million prior to recognizing the impairment.