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).)

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 JuneSeptember 30, 2009 and results of operations for all periods presented have been made.  The results of operations for the six-monthnine-month period ended JuneSeptember 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 generally intends to hold its MBS until maturity; however, from time to time, it may sell any of its securities be designated as either “held-to-maturity,” “available-for-sale” or “trading” atpart of the timeoverall management of acquisition.  Allits business.  As a result, all of the Company’s investment securitiesMBS are designated as available-for-sale“available-for-sale” and, accordingly are carried at their fair value with unrealized gains and losses excluded from earnings (except when an other-than-temporary impairment is recognized, as discussed below) and reported in other comprehensive income/(loss), a component of Stockholders’ Equity.  (See Note 2(j).)

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) to earnings as a realized gain or loss using the specific identification method.

Interest income on securities is accrued based on the outstanding principal balance of the investment securities and their contractual terms.  Premiums and discounts associated with 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.  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”).activity.

The Company determines the fair value of its Agency MBS based upon prices obtained from a third-party pricing service, which are indicative of market activity.  In determining the fair value of its non-Agency MBS, management judgment is used to arrive at fair value that considers prices obtained from a third-party pricing service, broker quotes received and other applicable market based data.  If listed prices or quotes are not available, then fair value is based upon internally developed models that are primarily usebased on observable market-based inputs, in order to arrive at the securities fair value.inputs.  (See Note 14.)  13)

When the fair value of an investment security is less than its amortized cost at the balance sheet date, of the reporting period for which impairmentsecurity is assessed, the impairment is designatedconsidered impaired.  The Company assesses its impaired securities on at least a quarterly basis, and designates such impairments as either “temporary” or “other-than-temporary.”  The Company assesses its securities for other-than-temporary impairment on at least a quarterly basis, applying the guidance prescribed in FSP No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” and, by FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” (“FSP 115-2”), which was adopted April 1, 2009 and EITF 99-20-1, which was adopted by the Company on December 31, 2008.

Impairments recognized as a component ofthrough other comprehensive income/(loss) on the consolidated balance sheet.   (See Note 2(n).)

Cash and cash equivalents include cash on deposit with financial institutions and investments in high quality 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 (i.e., margin calls made by the Company).  (See Note 8)  The Company did not hold any cash pledged by its counterparties at JuneSeptember 30, 2009 and held $5.5 million of cash pledged by its counterparties at December 31, 2008.  At JuneSeptember 30, 2009, all of the Company’s cash investments were in high quality overnight money market 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 counterparties to the Company’s repurchase agreements and/or repurchase agreement counterpartiesSwaps, 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 Swaps of $39.9$44.0 million and $70.7 million at JuneSeptember 30, 2009 and December 31, 2008, respectively.  (See Notes 54 and 8.)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 JuneSeptember 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, or more frequently under certain circumstances, at the entity level and, through Junelevel.  Through September 30, 2009, the Company had not recognized any impairment against its goodwill.

At JuneSeptember 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.)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 the 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 aswhen the value of the MBS pledged as collateral declines as the MBSa result of principal is repaid,amortization 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 in response to meet anya margin calls.call.  (See Notes 2(l), 7 and 8.)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 enteringenters 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 JuneSeptember 30, 2009, the Company had outstanding balances under repurchase agreements with 18 separate lenders with a maximum amount 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 $116.0$123.0 million, or 7.0%5.6% of stockholders’ equity, related to repurchase agreements.  (See Note 7.)Notes 4 and 7)

Forfeiture provisions for dividends and DERs on unvested equity instruments on the Company’s equity based awards vary by award.  To the extent that equity awards do not vest and grantees are not required to return such dividend payments of dividends or DERs to the Company, additional compensation expense is recorded at the time an award is forfeited.  (See Note 13.)2(i) and 12)

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.DERs.  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 RSUsrestricted stock units (“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 comprehensive income/(loss) includes net income/(loss), the change in net unrealized gains/(losses) on its investment securitiesMBS 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.

As part of the Company’s interest rate risk management, process, it periodically hedges a portion of its interest rate risk by enteringusing derivative financial instruments and does not enter into derivative financial instrument contracts.transactions for speculative or trading purposes and, accordingly, accounts for its Swaps as cash flow hedges.  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.  The Company accounts for its Swaps in accordance with FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“FAS 133”).  No cost is incurred at the inception of a Swap, underpursuant to 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 a quarterly basis thereafter, whether or not the hedge is “highly effective,effective.” in accordance with FAS 133.

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 theAlthough permitted under certain 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 5,4, 8 and 14.13)

On January 1, 2009, the Company adopted new accounting guidance required for certain transfers of financial assets and repurchase financings.  Given that this guidance was prospective, the initial adoption had no impact on the Company’s consolidated financial statements.  Under the new accounting guidance, it is presumed that the initial transfer of a financial asset (i.e., the purchase of an MBS by the Company) and repurchase financing of this MBS with the same counterparty are considered part of the same arrangement, or a “linked transaction.”  The two components of a linked transaction (MBS purchase and repurchase financing) are not reported separately but are netted together and reported as a derivative instrument, specifically as a net forward contract on the Company’s consolidated balance sheet.  In addition, changes in the fair value of the net forward contract are reported as gains or losses on the Company’s consolidated statements of operation and are not included in other comprehensive income/(loss).  (See Note 2(b))  However, if certain criteria are met, the initial transfer (i.e., purchase of a security by the Company) and repurchase financing will not be treated as a linked transaction and will be evaluated and reported separately, as an MBS purchase and repurchase financing.

The Company applies the provisionsCompany’s presentation of FAS No. 157, “Fair Value Measurements” (“FAS 157”), which defines fair value providesfor its financial assets and liabilities are determined within a framework for measuring fair value in accordance with GAAP and sets forth certain disclosures about fair value measurements.  FAS 157that stipulates that the exchange pricefair value of a financial asset or liability is thean exchange 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 providesThis definition of fair value is based on 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 athe 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(n) and 14.)13)

On January 1, 2009, the Company adopted EITF 03-6-1, which providesnew accounting guidance became effective providing 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 thatThe Company adopted this guidance on January 1, 2009 and retrospectively adjusted 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, 2009which did not have a material impact on the Company’sits historical EPS amounts.

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

The Company’s ARM-MBSMBS are primarily comprised of Agency MBS and, to a lesser extent, non-Agency MBS.  The Company’s MBS do not have a single maturity date and, further, the mortgage loans underlying ARM-MBS have interest rates that do not all reset at the same time.  In addition, the Company may have investments in other mortgage-related securities and other investments,MBS, which may or may not be rated.  The Company may pledgepledges a significant portion of its MBS as collateral against its repurchase agreements and Swaps.  (See Note 8.)8)