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We may be affected by deficiencies in foreclosure practices of third parties, as well as related delays in the foreclosure process.

        Deficiencies in foreclosure documentation by, among others, several large mortgage servicers have raised various concerns relating to foreclosure practices, and a group consisting of state attorneys general and state bank and mortgage regulators in all 50 states and the District of Columbia has been reviewing foreclosure practices in their various jurisdictions. A number of mortgage servicers temporarily suspended foreclosure proceedings in some or all states in which they do business while they reviewed and made modifications to their foreclosure practices. Any extension of foreclosure timelines can increase the inventory backlog of distressed homes on the market and creates greater uncertainty about housing prices. Prior to making investments in RMBS, we expect our Manager to carefully consider many factors, including housing prices and foreclosure timelines, and estimate loss assumptions. The concerns about deficiencies in foreclosure practices of servicers and related delays in the foreclosure process may impact our loss assumptions and affect the values of, and our returns on, our investments in RMBS.

The commercial mortgage loans underlying the CMBS we may acquire will be subject to defaults, foreclosure timeline extension, fraud and commercial price depreciation and unfavorable modification of loan principal amount, interest rate and amortization of principal, which could result in losses to us.

        CMBS aremay be secured by a single commercial mortgage loan or a pool of commercial mortgage loans. Commercial mortgage loans aremay be secured by multifamily or commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that may be greater than similar risks associated with loans made on the security of residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability or willingness to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things,

•

tenant mix;



•

success of tenant businesses;



•

property management decisions;



•

property location and condition;



•

competition from comparable types of properties;



•

changes in laws that increase operating expenses or limit rents that may be charged;



•

any need to address environmental contamination at the property or the occurrence of any uninsured casualty at the property;

Accounting Standards Board, or FASB, issued guidance that clarifies its intent regarding the application of existing fair value measurement requirements including: (i) prohibiting the inclusion of block discountsAdopted in all fair value measurements, not just Level I measurements; (ii) adding guidance on when to include other premiums and discounts in fair value measurements; (iii) clarifying that the concepts of "highest and best use" and "valuation premise" apply only when measuring the fair value of non-financial assets; and (iv) adding an exception that allows the measurement of a group of financial assets and liabilities with offsetting risks (a portfolio of derivative contracts) at their net exposure to a particular risk if certain criteria are met. For non-public entities, this guidance is effective for fiscal years beginning after December 15, 2011. The adoption of this guidance did not have a material impact on our financial statements.

Accounting Standards to be Adopted by us in Future Periods2013

        In December 2011, the FASB issued guidance requiring additional disclosure information about offsetting and related arrangements. Further in December 2012, the FASB proposed an update intended to address implementation of the December 2011 guidance. In January 2013, the FASB issued guidance to limit the scope of the new balance sheet and offsetting disclosure requirements of prior guidance related to certain derivatives (including bifurcated embedded derivatives,)derivatives), repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions. Entities will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet as well as instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements, and reverse sale and repurchase agreements, and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards. The guidance is effective for periods beginning on or after January 1, 2013 and interim periods within those annual periods. While this guidance may resultresulted in certain additional disclosures, it isdid not expected to have a material impact on our financial statements.




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Results of Operations

        The following discussion of our results of operations highlights our performance for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012. For the year ended December 31, 2013, we had a net loss of $27.9 million or $1.19 per basic and diluted weighted average common share. From May 15, 2012 (commencement of operations) through December 31, 2012, we had net income of $57.3 million or $3.64 per basic and $3.63 diluted weighted average common share. During 2013, we expanded our investment in Non-Agency MBS and commenced investing in CMBS and adjusted our overall leverage and hedging strategy pursuant to our current business plan. Accordingly, operating results for the partial period from May 15, 2012 through December 31, 2012 may not to be fully comparable with the results of our operations for the full year ended December 31, 2013.




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Investments

        The following table presents certain information about our RMBSMBS investment portfolio at December 31, 20122013 which is a Non-GAAP measure due to the inclusion of our Linked Transactions, in order to present a complete economic presentation of our MBS portfolio, which is reconciled to GAAP below, as follows (dollars in thousands):

		Principal Balance			Unamortized Premium (Discount)			Non-Accretable Discount			Amortized Cost			Unrealized Gain (Loss)			Estimated Fair Value			Net Weighted Average Coupon(1)
20-Year Mortgage
Coupon Rate:
3.00%		$	221,582		$	13,884		$	—		$	235,466		$	(1,475	)	$	233,991			3.0	%
3.50%			36,966			2,023						38,989			829			39,818			3.5	%
4.00%			40,703			4,553						45,256			(181	)		45,075			4.0	%
			299,251			20,460						319,711			(827	)		318,884			3.2	%
30-Year Mortgage
Coupon Rate:
3.00%			242,392			10,919						253,311			1,506			254,817			3.0	%
3.50%			2,733,814			211,225						2,945,039			14,786			2,959,825			3.5	%
4.00%			1,097,941			117,104						1,215,045			3,299			1,218,344			4.0	%
5.50%			93,092			11,585						104,677			(1,969	)		102,708			5.5	%
6.00%			12,865			1,545						14,410			(133	)		14,277			6.0	%
			4,180,104			352,378						4,532,482			17,489			4,549,971			3.7	%
CMO—Fixed Rate			66,000			9,776						75,776			(1,546	)		74,230			6.5	%
Agency IOs and IIOs(2)			N/A			N/A						176,093			(1,057	)		175,036			4.5	%
Agency IOs and IIOs accounted for as derivatives(2)(3)			N/A			N/A						N/A			N/A			75,387			4.9	%
			N/A			N/A						176,093			(1,057	)		250,423			4.6	%
Non-Agency RMBS			37,372			(5,511	)		(12,659	)		19,202			(129	)		19,073			0.5	%
Total		$	4,582,727		$	377,103		$	(12,659	)	$	5,123,264		$	13,930		$	5,212,581			3.9	%

		Principal Balance			Unamortized Premium (Discount)			Discount Designated as Credit Reserve and OTTI			Amortized Cost			Unrealized Gain (Loss)			Estimated Fair Value			Net Weighted Average Coupon(1)
20-Year Mortgage
Coupon Rate:
3.00%		$	365,951		$	18,007		$	—		$	383,958		$	(22,100	)	$	361,858			3.0	%
3.50%			99,771			6,429			—			106,200			(4,570	)		101,630			3.5	%
4.00%			38,301			4,062			—			42,363			(2,925	)		39,438			4.0	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
			504,023			28,498			—			532,521			(29,595	)		502,926			3.2	%
30-Year Mortgage
Coupon Rate:
3.50%			1,024,666			74,235			—			1,098,901			(85,741	)		1,013,160			3.5	%
4.00%			559,939			57,848			—			617,787			(41,366	)		576,421			4.0	%
5.50%			84,274			11,196			—			95,470			(838	)		94,632			5.5	%
6.00%			8,984			1,077			—			10,061			(36	)		10,025			6.0	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
			1,677,863			144,356			—			1,822,219			(127,981	)		1,694,238			3.8	%
CMO—Fixed-Rate									—													%
Agency RMBS IOs and IIOs(2)			N/A			N/A			—			158,825			4,084			162,909			4.4	%
Agency and Non-Agency IIOs and IIOs accounted for as derivatives(2)(3)			N/A			N/A			N/A			N/A			N/A			109,235			4.6	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
			N/A			N/A			—			158,825			4,084			272,144			4.5	%
Non-Agency RMBS			526,011			(5,389	)		(98,149	)		422,473			7,991			430,464			5.1	%
Non-Agency RMBS IOs			N/A			N/A			N/A			7,420			70			7,490			5.2	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
			526,011			(5,389	)		(98,149	)		429,893			8,061			437,954			5.1	%
Agency and Non-Agency CMBS			11,979			(3,446	)		—			8,533			996			9,529			1.6	%
Agency and Non-Agency CMBS IOs and IIOs(2)			N/A			N/A			N/A			16,682			(140	)		16,542			0.8	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Non GAAP Basis-Including Linked Transaction			2,719,876			164,007			(98,149	)		2,968,673			(144,575	)		2,933,333			3.9	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Linked Transactions			56,028			41,835			(18,251	)		79,612			134			79,746			27.1	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: GAAP Basis		$	2,663,848		$	122,184		$	(79,898	)	$	2,889,061		$	(144,709	)	$	2,853,587			3.6	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

Net weighted average coupon as of December 31, 20122013 is presented net of servicing and other fees.



(2)

Agency RMBS IOs and IIOs, Non-Agency RMBS IOs, Agency and AgencyNon-Agency IOs and IIOs, accounted for as derivatives, and Agency and Non-Agency CMBS IOs and IIOs have no principal balances and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on interest-only class of securities. At December 31, 2013, the notional balance for Agency RMBS IOs and IIOs, Non-Agency IOs, for Agency and Non-Agency IOs and IIOs, accounted for as derivatives, and Agency and Non-Agency CMBS IOs was $910,628, $53,960, $686,232 and $282,326, respectively.



(3)

Interest on these securities is reported as a component of LossGain (loss) on derivative instruments.instruments, net.




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        As of December 31, 2013 and December 31, 2012, our portfolio consisted primarily of fixed ratefixed-rate Agency RMBS which our Manager believes exhibit prepayment mitigation attributes, including Agency RMBS collateralized by low loan balances, loans where the underlying borrower is unable to access the Making Home Affordable Program, including the Home Affordable Refinance Program or HARP or loans which were not originated by third party originators or brokers.




Table        The following table details the constant prepayment rates for our Agency portfolio as of ContentsDecember 31, 2013, based on our Manager's estimates which are based on third party models, as adjusted by our Manager, and are updated quarterly on a prospective basis:

Constant Prepayment Rates		Low			High
Agency RMBS
20-Year Mortgage			3.47	%		14.19	%
30-Year Mortgage			4.31	%		38.44	%
Agency RMBS IOs and IIOs			4.04	%		29.33	%
Agency IOs and IIOs accounted for as derivatives			3.81	%		31.64	%
Agency CMBS IOs(1)			N/A			N/A

---

(1)

CMBS generally include prepayment restrictions; therefore, there are no Constant Prepayment Rates available.

        The following table details information for our Non-Agency portfolio as of December 31, 2013, based on our Manager's estimates which are based on third party models, as adjusted by our Manager, and are updated quarterly on a prospective basis:

		Cumulative Default						Cumulative Severity						Cumulative 5-Year CRR
		Low			High			Low			High			Low			High
Non-Agency RMBS			0.88	%		66.41	%		0.00	%		89.45	%		2.12	%		10.66	%
Non-Agency IOs and IIOs			23.91	%		33.85	%		15.23	%		56.93	%		4.49	%		11.13	%
Non-Agency CMBS			14.47	%		14.47	%		32.72	%		32.72	%		10.97	%		10.97	%
Linked transactions, net, at fair value			4.94	%		62.50	%		29.77	%		113.79	%		3.60	%		14.34	%

Investment Activity

Agency and Non-Agency RMBS, Agency Derivativesand Non-Agency CMBS, IO and IIO Securities and Other Securities.

        The following tables present our MBS portfolio activity, including linked transactions (Non-GAAP) for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012 (dollars in thousands):

		For the year ended December 31, 2013
		Purchases			Principal Payments and Basis Recovery			Proceeds from Sales
Agency RMBS and Agency RMBS IOs and IIOs		$	1,581,736		$	288,257		$	3,491,805
Non-Agency RMBS			393,976			17,132			128,683
Agency CMBS and Agency CMBS IOs and IIOs			20,559			385			—
Non-Agency CMBS			8,325			—			—
​	​	​	​	​	​	​	​	​	​	​
Total MBS: Excluding Linked Transactions (GAAP)		$	2,004,596		$	305,774		$	3,620,488
​	​	​	​	​	​	​	​	​	​	​
Agency RMBS Linked Transactions			9,705			58			—
Non-Agency RMBS Linked Transactions			166,923			1,950			21,735
​	​	​	​	​	​	​	​	​	​	​
Total MBS: Including Linked Transactions (Non-GAAP)		$	2,181,224		$	307,782		$	3,642,223
​	​	​	​	​	​	​	​	​	​	​
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		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
		Purchases			Principal Payments and Basis Recovery			Proceeds from Sales
Agency RMBS		$	7,679,165		$	105,681		$	2,389,472
Non-Agency RMBS			19,147			67			—
Other Securities			100,655			—			100,854
​	​	​	​	​	​	​	​	​	​	​
Total MBS (GAAP)		$	7,798,967		$	105,748		$	2,490,326
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

        For the year ended December 31, 2013, we settled certain derivatives realizing a net gain of approximately $1.7 million from the unlinking of securities previously accounted for as derivatives through linked transactions. We reclassify, from mark-to-market, adjustments on linked transactions to realized gain (loss) on linked transactions during the period the security becomes unlinked. For the period from May 15, 2012 (commencement of operations) through December 31, 2012 we acquired approximately $7.7 billiondid not realize any gains or losses on unlinking of Agency RMBS and Agencysecurities previously accounted for as derivatives approximately $19.1 millionthrough linked transactions.

        The following table presents the vintage of Non-Agency RMBS and approximately $100.7 million of other securities consisting of U.S Treasury Notes. During the same period, we received principal payments and basis recoveries of approximately $105.7 million for Agency RMBS and Agency derivatives and approximately $67 thousand for Non-Agency RMBS. Proceeds from sales received for the period from May 15, 2012 (commencement of operations) throughour MBS investment portfolio, including linked transactions at December 31, 2012 were approximately $2.4 billion for Agency RMBS and Agency derivatives and approximately $100.9 million for other securities. In addition, we entered into forward contracts to purchase TBAs2013:

		1998			2000			2002			2003			2004			2005			2006			2007			2008			2009			2010			2011			2012			2013			Total
Agency RMBS
20-Year Mortgage			—			—			—			—			—			—			—			—			—			—			—			—			10.2	%		6.9	%		17.1	%
30-Year Mortgage			—			—			—			—			—			—			0.3	%		—			—			0.5	%		2.6	%		0.2	%		37.6	%		16.7	%		57.9	%
Agency Interest Only—Strips			—			—			—			0.1	%		0.1	%		0.2	%		0.2	%		—			0.4	%		0.3	%		0.2	%		—			4.0	%		—			5.5	%
Agency and Non-Agency Interest-Only Strips, accounted for as derivatives			—			0.4	%		—			—			—			—			—			—			0.1	%		—			0.4	%		0.3	%		1.9	%		0.5	%		3.6	%
Non-Agency RMBS			0.2	%		—			0.5	%		0.4	%		0.8	%		3.7	%		4.0	%		1.8	%		—			—			—			—			0.9	%		—			12.3	%
Non-Agency Linked Transactions			—			—			—			—			—			0.6	%		1.0	%		1.1	%		—			—			—			—			—			—			2.7	%
Agency and Non-Agency CMBS			—			—			—			—			—			—			0.3	%		—			—			—			—			—			—			—			0.3	%
Agency and Non-Agency CMBS Interest-Only Strips			—			—			—			—			—			—			—			—			—			—			—			—			0.2	%		0.4	%		0.6	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total MBS (Non-GAAP)			0.2	%		0.4	%		0.5	%		0.5	%		0.9	%		4.5	%		5.8	%		2.9	%		0.5	%		0.8	%		3.2	%		0.5	%		54.8	%		24.5	%		100.0	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

        As of approximately $442.0 million and we entered into forward contracts to sell TBAs of approximately $443.9 million to be settled in Q1 2013. The average unlevered yield on Agency RMBS, including Agency derivatives, for the period from May 15, 2012 (commencement of operations) through December 31, 2012 was approximately 2.8%. For2013 the same period,weighted average expected remaining term to the average unlevered yield on Non-Agency RMBS was approximately 10.5%.expected maturity of our investment portfolio, including linked transactions is 8.6 years.

        Financing and Other Liabilities.    We have entered into repurchase agreements to finance a substantial majority of our Agency RMBS.MBS. These agreements are secured by substantially all of our Agency RMBSMBS and bear interest at rates that have historically moved in close relationship to LIBOR. ForThe following table summarizes the fair value of MBS collateral pledged as of December 31, 2013 and 2012.

		December 31, 2013						December 31, 2012
Collateral		Repurchase Agreement Borrowings Outstanding			Fair Value of MBS Collateral Pledged			Repurchase Agreement Borrowings Outstanding			Fair Value of MBS Collateral Pledged
Agency RMBS		$	2,331,276		$	2,463,347		$	4,794,730		$	5,043,824
Non-Agency RMBS			230,247			332,003			—			—
Agency and Non-Agency CMBS			17,544			23,597			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Excluding Linked Transactions		$	2,579,067		$	2,818,947		$	4,794,730		$	5,043,824
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Agency RMBS Linked Transactions			—			—			—			—
Non-Agency RMBS Linked Transactions			61,187			79,746			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Including Linked Transactions (Non-GAAP)		$	2,640,254		$	2,898,693		$	4,794,730		$	5,043,824
​	​	​	​	​	​	​	​	​	​	​	​	​	​
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        The following table presents our borrowing activity, by type of collateral pledged, for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012,2012:

		For the year ended December 31, 2013						For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Collateral		Proceeds			Repayments			Proceeds			Repayments
Agency RMBS		$	28,892,822		$	31,356,276		$	14,511,707		$	9,716,977
Non-Agency RMBS			1,019,421			789,174			—			—
Agency and Non-Agency CMBS			35,963			18,419			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Excluding Linked Transactions		$	29,948,206		$	32,163,869		$	14,511,707		$	9,716,977
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Agency RMBS Linked Transactions			18,618			18,618			—			—
Non-Agency RMBS Linked Transactions			146,471			85,284			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	30,113,295		$	32,267,771		$	14,511,707		$	9,716,977
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

        At December 31, 2013, we received proceedshad outstanding repurchase agreement borrowings with the following 16 counterparties totaling approximately $2.6 billion, which is a Non-GAAP measure due to our Linked Transactions, which is reconciled to GAAP below as follows:

(dollars in thousands) Repurchase Agreement Counterparties		Amount Outstanding			Percent of Total Amount Outstanding			Fair Value of Company MBS Held as Collateral			Counterparty Rating(2)
Barclays Capital Inc.(1)		$	362,476			13.7	%	$	414,344		A
Deutsche Bank Securities LLC(1)			356,372			13.5	%		381,319		A
Goldman Sachs Bank USA(1)			306,708			11.6	%		328,504		A
JP Morgan Securities LLC(1)			271,887			10.3	%		313,967		A+
Citigroup Global Markets Inc.(1)			205,856			7.8	%		213,358		A
Credit Suisse Securities (USA) LLC(1)			178,896			6.8	%		235,680		A
Mizuho Securities USA Inc.(1)			173,030			6.6	%		178,101		(P)A2
BNP Paribas Securities Corporation.(1)			152,084			5.8	%		164,025		A+
Merrill Lynch Pierce Fenner & Smith Inc.(1)			142,665			5.4	%		148,351		A
UBS Securities LLC(1)			130,833			5.0	%		133,938		A
South Street Securities LLC(1)			100,818			3.8	%		105,020		AA+
Jefferies & Company Inc.(1)			100,762			3.8	%		104,302		BBB
RBC Capital Markets LLC(1)			56,222			2.1	%		61,898		AA-
RBS Securities Inc.(1)			51,138			1.9	%		52,625		A-
The Royal Bank of Scotland plc(1)			37,993			1.4	%		50,834		BBB+
Morgan Stanley & Co. LLC			12,514			0.5	%		12,427		A
​	​	​	​	​	​	​	​	​	​	​	​
Total: Non-GAAP Basis—Including Linked Transactions		$	2,640,254			100.0	%	$	2,898,693
​	​	​	​	​	​	​	​	​	​	​	​
Linked Transactions			61,187			—			79,746
​	​	​	​	​	​	​	​	​	​	​	​
Total: GAAP Basis—Excluding Linked Transactions		$	2,579,067			—		$	2,818,947
​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Counterparty holds collateral valued in excess of 5% of our stockholders' equity as security for our obligations under the applicable repurchase agreements as of December 31, 2013.



(2)

The counterparty rating presented above is the long-term issuer credit rating as rated at March 12, 2014 by S&P, except for Mizuho Securities USA Inc. which is the long-term issuer credit rating by Moody's at March 12, 2014.




Table of Contents

        In reviewing our various master repurchase agreements, we determined that at June 30, 2013, the ratio of our Agency MBS to Total Assets was approximately $14.5 billion and made repayments89.6%, which, if unrounded, was below a 90% threshold for such ratio as determined by our then current leverage ratio contained in two of approximately $9.7 billionour master repurchase agreements (only one of which had transactions then outstanding). If such ratio is determined to be below the required threshold, the counterparties to the master repurchase agreements may elect to seek to terminate existing repurchase transactions under the master repurchase agreements. In addition to previously providing such counterparties with our financial documents, we, in March 2014 provided each counterparty with specific notice with regard to the June 30, 2013 calculation. To date, both counterparties have continued to fund and enter into new repo transactions with us and at both September 30, 2013 and December 31, 2013 we exceeded any applicable asset ratios. Neither of the counterparties has indicated any intention to seek to terminate any existing repurchase agreements. Further, as previously stated, repo financing does not represent a committed facility and, accordingly, any repo counterparty can elect to cease providing us financing at any time for any reason. Thus any early termination would have only a short term impact on our legal rights. While we do not expect any of the aforementioned counterparties to do so, based on our analysis, we believe we have sufficient liquidity and alternative financing sources, primarily other repo financing providers, to finance our portfolio and continue to operate our business in the normal course and for the foreseeable future regardless if either or both such counterparties elect to terminate their financing relationships with us.

At December December��31, 2012, we had outstanding repurchase agreement borrowings with the following 14 counterparties totaling approximately $4.8 billion:

(dollars in thousands) Repurchase Agreement Counterparties		Amount Outstanding			Percent of Total Amount Outstanding			Company MBS Held as Collateral(1)
Deutsche Bank Securities LLC		$	730,227			15.2	%	$	763,876
JP Morgan Securities LLC			575,880			12.0	%		619,547
Citigroup Global Markets Inc.			481,252			10.0	%		504,712
Barclays Capital Inc.			398,172			8.3	%		419,038
BNP Paribas Securities Corporation			361,701			7.5	%		382,338
Mizuho Securities USA Inc.			308,740			6.4	%		323,329
Credit Suisse Securities (USA) LLC			300,222			6.3	%		311,860
RBC Capital Markets LLC			292,648			6.1	%		307,461
Merrill Lynch Pierce Fenner & Smith Inc.			262,082			5.5	%		273,770
Morgan Stanley & Co. LLC			253,862			5.3	%		264,412
Goldman Sachs Bank USA			247,416			5.2	%		261,553
Wells Fargo Securities LLC & Wells Fargo Bank N.A.			199,087			4.2	%		209,171
UBS Securities LLC			197,947			4.1	%		207,233
Jefferies & Company Inc.			185,494			3.9	%		195,524
Total		$	4,794,730			100.0	%	$	5,043,824

(1)

At fair value.

(dollars in thousands) Repurchase Agreement Counterparties		Amount Outstanding			Percent of Total Amount Outstanding			Fair Value of Company MBS Held as Collateral
Deutsche Bank Securities LLC		$	730,227			15.2	%	$	763,876
JP Morgan Securities LLC			575,880			12.0	%		619,547
Citigroup Global Markets Inc.			481,252			10.0	%		504,712
Barclays Capital Inc.			398,172			8.3	%		419,038
BNP Paribas Securities Corporation			361,701			7.5	%		382,338
Mizuho Securities USA Inc.			308,740			6.4	%		323,329
Credit Suisse Securities (USA) LLC			300,222			6.3	%		311,860
RBC Capital Markets LLC			292,648			6.1	%		307,461
Merrill Lynch Pierce Fenner & Smith Inc.			262,082			5.5	%		273,770
Morgan Stanley & Co. LLC			253,862			5.3	%		264,412
Goldman Sachs Bank USA			247,416			5.2	%		261,553
Wells Fargo Securities LLC & Wells Fargo Bank N.A.			199,087			4.2	%		209,171
UBS Securities LLC			197,947			4.1	%		207,233
Jefferies & Company Inc.			185,494			3.9	%		195,524
​	​	​	​	​	​	​	​	​	​	​
Total		$	4,794,730			100.0	%	$	5,043,824
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

        We record the liability for RMBSMBS and other securities purchased, for which settlement has not taken place as an investment related payable. As of December 31, 2012,2013, we had no investment related payables.payables of $0.




Table of Contents

        The following table presents our borrowings by type of collateral pledged as of December 31, 2013 and December 31, 2012, and the respective Effective Cost of Funds (non-GAAPfor the periods then ended (dollars in thousands):

Collateral		Balance (GAAP) December 31, 2013			Weighted Average Cost of Funds for the year ended December 31, 2013			Balance (GAAP) December 31, 2012			Weighted Average Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012
Agency RMBS		$	2,331,276			0.43	%	$	4,794,730			0.45	%
Non-Agency RMBS			230,247			1.77			—			—
Agency and Non-Agency CMBS			17,544			1.39			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,579,067			0.47	%	$	4,794,730			0.45	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

        The following table presents our borrowings by type of collateral pledged as of December 31, 2013 and December 31, 2012, and the respective Effective Cost of Funds (Non-GAAP financial measure) for the periodperiods then ended (dollars in thousands) See "Non-GAAP financial measures" (dollars in thousands):

Collateral		Balance (Non- GAAP) December 31, 2013			Weighted Average Effective Cost of Funds for the year ended December 31, 2013(1)			Balance (Non- GAAP) December 31, 2012			Weighted Average Effective Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012(1)
Agency RMBS		$	2,331,276			1.05	%	$	4,794,730			0.80	%
Non-Agency RMBS			230,247			1.77			—			—
Agency and Non-Agency CMBS			17,544			1.39			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Excluding Linked Transactions		$	2,579,067			1.08	%	$	4,794,730			0.80	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Agency RMBS Linked Transactions			—			0.38			—			—
Non-Agency RMBS Linked Transactions			61,187			1.78			—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,640,254			1.08	%	$	4,794,730			0.80	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

Collateral		Balance December 31, 2012			Weighted Average Cost of Funds for the three months ended December 31, 2012			Weighted Average Effective Cost of Funds for the three months ended December 31, 2012(1)			Weighted Average Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012			Weighted Average Effective Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012(1)
Agency RMBS		$	4,794,730			0.47	%		0.81	%		0.45	%		0.80	%
Total		$	4,794,730			0.47	%		0.81	%		0.45	%		0.80	%

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(1)

The effective cost of funds for the periods presentedyear ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, are calculated on an annualized basis and include interest expense for the periods and net payments on interest rate swaps of approximately $4.0$22.9 million and approximately $6.3 million, respectively, interest payments on Agency linked transactions of approximately $6 thousand and $0, respectively and interest payments on Non-Agency linked transactions of approximately $265 thousand and $0, respectively. While swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates on our liabilities and are classified as hedges for purposes of satisfying the REIT tax requirements. In addition, although certain securities and their respective repurchase borrowings are classified as derivatives, we view the interest expense attributed to these borrowings as additional cost of funds. See "Non"Non-GAAP Financial Measures."




Table of Contents

        The following table presents our average borrowings, by type of collateral pledged, on a GAAP Financial Measures".and Non-GAAP basis for the year ended December 31, 2013, and for the period from May 15, 2012 (commencement of operations) through December 31, 2012 (in thousands):

Collateral		For the year ended December 31, 2013			For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Agency RMBS		$	3,681,656		$	2,840,999
Non-Agency RMBS			119,310			—
Agency and Non-Agency CMBS			4,525			—
​	​	​	​	​	​	​	​
Total: Excluding Linked Transactions (GAAP)		$	3,805,491		$	2,840,999
​	​	​	​	​	​	​	​
Agency RMBS Linked Transactions (Non-GAAP)			1,575			—
Non-Agency RMBS Linked Transactions (Non-GAAP)			14,860			—
​	​	​	​	​	​	​	​
Total (Non-GAAP)		$	3,821,926		$	2,840,999
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​
Maximum borrowings during the period (Non-GAAP)(1)			4,808,778			4,900,556

---

(1)

Amount represents the maximum borrowings at month-end during each of the respective periods.

        Derivative Instruments.    As of December 31, 2012,2013, we had entered into swaps and swaptions designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements.agreements as such repurchase agreements are renewed and/or extended. The swaps generally provide for fixed interest rates indexed off of LIBOR and are viewed by us to effectively fix the floating interest rates, net of variable-rate payment swaps, on approximately $2.8$2.1 billion of borrowings under our repurchase agreements, excluding forward starting swaps of $491.6 million as of December 31, 2012.2013. During the year ended December 31, 2013, we de-levered our balance sheet in order to take advantage of attractive valuations in the Non-Agency RMBS and CMBS. In addition to selling Agency MBS pass through securities, we reduced our borrowings under repurchase agreements and adjusted our interest rate swap holdings by terminating approximately 2.8 billion notional amount. This resulted in a net realized gain on derivative instruments of approximately $65.3 million. In addition, during the year, we entered into swaptions which resulted in a net realized gain on derivative instruments of approximately $ 26.7 million.

        The following table presents information about our fixed pay rate interest rate swaps as of December 31, 2013 (dollars in thousands):

Remaining Interest Rate interest rate swap Term		Notional Amount			Average Fixed Pay Rate			Average Maturity (Years)			Forward Starting
1 year or less		$	215,900			0.4	%		0.8			—	%
Greater than 1 year and less than 3 years			179,100			0.5			1.9			—
Greater than 3 years and less than 5 years			574,200			1.3			4.4			—
Greater than 5 years			1,718,650			2.4			10.8			28.6
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,687,850			1.9	%		8.0			18.3	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​




Table of Contents

        The following table presents information about our variable pay rate interest rate swaps as of December 31, 2013 (dollars in thousands):

Remaining Interest Rate interest rate swap Term		Notional Amount			Average Variable Pay Rate			Average Maturity (Years)			Forward Starting
Greater than 3 years and less than 5 years		$	81,000			0.2	%		4.8			—	%
Greater than 5 years			46,000			0.2			24.1			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	127,000			0.2	%		11.8			—	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

        At December 31, 2013, we had entered into six swaptions with notional amounts ranging from $100.0 million to $1.5 billion which expire between May 1, 2014 and October 28, 2014. If exercised, we can enter into seven year and ten year fixed pay swap agreement at a predetermined strike price. At December 31, 2013 we had also entered into a swaption with a notional amount of $100.0 million that expires in May 1, 2014. If exercised, we can enter into a ten year variable pay swap agreement.

        We also purchased or shorted TBAs. As of December 31, 2013 and December 31, 2012, we had contracts to purchase ("long position") and sell ("short position") TBAs on a forward basis. Following is a summary of our long and short TBA positions reported in Derivative assets, at fair value on the Balance Sheet as of December 31, 2013 and December 31, 2012 (dollars in thousands):

Remaining Interest Rate interest rate swap Term		Notional Amount			Average Fixed Pay Rate			Average Maturity (Years)			Forward Starting
Greater than 1 year and less than 3 years		$	762,800			0.4	%		2.3			22.7	%
Greater than 3 years and less than 5 years			439,500			0.8			4.8			10.2
Greater than 5 years			1,609,500			1.7			10.2			30.1
Total		$	2,811,800			1.2	%		7.2			25.0	%

		December 31, 2013						December 31, 2012
		Notional Amount			Fair Value			Notional Amount			Fair Value
Purchase contracts, asset		$	13,600		$	35		$	425,000		$	3,056
​	​	​	​	​	​	​	​	​	​	​	​	​	​
TBA securities, asset			13,600			35			425,000			3,056
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Purchase contracts, liability			176,400			(1,207	)		—			—
Sale contracts, liability			—			—			(425,000	)		(1,219	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​
TBA securities, liability			176,400			(1,207	)		(425,000	)		(1,219	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​
TBA securities, net		$	190,000		$	(1,172	)	$	—		$	1,837
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

 At December 31, 2012, we had entered into two swaptions with a notional amount


		Notional Amount as of December 31, 2012			Additions			Settlement, Termination, Expiration or Exercise			Notional Amount as of December 31, 2013
Purchase of TBAs		$	425,000			2,507,600		$	(2,742,600	)	$	190,000
Sale of TBAs		$	425,000			2,350,000		$	(2,775,000	)	$	—




Table of $445.0 million and $75.0 million which expire in nine months and seven months, respectively. If exercised, we can enter into a 20 year fixed pay swap agreement and a 10 year fixed pay swap agreement at a predetermined strike price, respectively.Contents

Net Interest Income

        We earned interest income, net of premium amortization and amortization/recovery of basis, and inclusive of discount accretion and amortization of basis, ofapproximately $125.3 million for the year ended December 31, 2013 and approximately $53.3 million for the period from May 15, 2012 (commencement of operations) through December 31, 2012 which represents interest earned on our assets. We incurred interest expense of approximately $18.0 million for the year ended December 31, 2013 and approximately $8.1 million for the period from May 15, 2012 (commencement of operations) through December 31, 2012, which was related to borrowings from repurchase agreements. Yields on Agency RMBS increased in 2013 corresponding to the increase on the yield on the ten year U.S. Treasury. Yields on Non-Agency RMBS decreased as result of continuing home price appreciation. Cost of fund remained relatively constant as the Federal Reserve continues to maintain its accommodative monetary policy.




		For the year ended December 31, 2013												For the period from Mary 15, 2012 (commencement of operations) through December 31, 2012
(dollars in thousands)		Agency RMBS			Non-Agency RMBS			Agency and Non- Agency CMBS			Total			Agency RMBS			Non-Agency RMBS			Agency and Non- Agency CMBS			Total
Average amortized cost of MBS		$	3,847,064		$	199,763		$	6,283		$	4,053,110		$	3,214,440		$	2,004		$	—		$	3,216,444
Total interest income(1)		$	111,851		$	13,039		$	438		$	125,328		$	53,185		$	133		$	—		$	53,318
Yield on average MBS			2.91	%		6.53	%		6.97	%		3.09	%		2.61	%		10.49	%		—	%		2.62	%
Average balance of repurchase agreements		$	3,681,655		$	119,310		$	4,525		$	3,805,490		$	2,840,999		$	—		$	—		$	2,840,999
Total interest expense		$	15,839		$	2,117		$	63		$	18,019		$	8,094		$	—		$	—		$	8,094
Average cost of funds(2)			0.43	%		1.77	%		1.39	%		0.47	%		0.45	%			%		—	%		0.45	%
Net interest income		$	96,012		$	10,922		$	375		$	107,309		$	45,091		$	133		$	—		$	45,224
Net interest rate spread			2.48	%		4.76	%		5.58	%		2.62	%		2.16	%		10.49	%		—			2.17	%

Table

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(1)

Amount includes net (amortization of Contents

Periodpremiums), accretion of discounts and (amortization/recovery of basis) of approximately $(60.3) million for Agency RMBS, approximately $8.3 million for Non-Agency RMBS, and approximately $(106) thousand for Agency and Non-Agency CMBS for year ended December 31, 2013. For the period from MayMary 15, 2012 (commencement of operations) through December 31, 2012:

(dollars in thousands)		Agency			Non-agency			Total
Average amortized cost of RMBS		$	3,214,440		$	2,004		$	3,216,444
Total interest income(1)		$	53,185		$	133		$	53,318
Yield on average RMBS			2.61	%		10.49	%		2.62	%
Average balance of repurchase agreements		$	2,840,999			—		$	2,840,999
Total interest expense		$	8,094			—		$	8,094
Average cost of funds(2)			0.45	%		—			0.45	%
Net interest income		$	45,091		$	133		$	45,224
Net interest rate spread			2.16	%		10.49	%		2.17	%

---

(1)

Amount2012, amount includes net amortization(amortization of premiums,premiums), accretion of discounts and amortization(amortization/recovery of basisbasis) of approximately of $(26.9) million for Agency and approximately $0.1RMBS, $123 thousand for Non-Agency RMBS. In accordance with GAAP, interest income does not include $1.4 million for Non-Agencylinked transactions for the period from May 15, 2012 (commencement of operations) throughyear ended December 31, 2012.2013; instead such amounts are included in gain (loss) on linked transactions.



(2)

CostFor the year ended December 31, 2013, cost of funds does not include accrual and settlement of interest associated with derivative instruments and linked transactions of approximately $22.9 million and $271 thousand, respectively. For the period from Mary 15, 2012 (commencement of operations) through December 31, 2012, cost of funds does not include interest of approximately $6.3 million associated with derivative instruments. In accordance with GAAP, thosesuch costs are included in gain (loss) on derivative instruments and gain (loss) on linked transactions, respectively, in the statementStatement of operations.Operations.




Table of Contents

        The following table sets forth certain information regarding our net investment income for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, See "Non-GAAP Financial Measures":

Period from May 15, 2012 (commencement of operations) throughFor the year ended December 31, 2012 (dollars in thousands):2013:

Non-GAAP Financial Measures:

(dollars in thousands)		Agency RMBS			Non-Agency RMBS			Agency and Non-Agency CMBS			Total
Average amortized cost of MBS held including Agency and Non-Agency Interest—Only Strips accounted for as derivatives and linked transactions		$	3,949,104		$	222,844		$	7,356		$	4,179,304
Total interest income including interest income on Agency and Non-Agency Interest—Only Strips accounted for as derivatives and linked transactions(1)		$	122,095		$	14,410		$	501		$	137,006
Yield on average amortized cost of MBS including adjustments related to cost of Agency and Non-Agency Interest—Only Strips accounted for as derivatives and linked transactions			3.09	%		6.47	%		6.81	%		3.28	%
Average balance of repurchase agreements, including repurchase agreements on linked transactions		$	3,683,230		$	134,170		$	4,525		$	3,821,925
Total interest expense including interest income (expense), net incurred on interest rate swaps and interest expense incurred on linked transactions(2)		$	38,777		$	2,382		$	63		$	41,222
Average cost of funds including interest income (expense) on Agency and Non-Agency Interest—Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions			1.05	%		1.78	%		1.39	%		1.08	%
Net interest income including interest income (expense) on Agency and Non-Agency Interest—Only Strips, accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions		$	83,318		$	12,028		$	438		$	95,784
Net interest rate spread including interest income (expense) on Agency and Non-Agency Interest—Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions			2.04	%		4.69	%		5.42	%		2.20	%

Non-GAAP Financial Measures:		Agency			Non-agency			Total
Average amortized cost of RMBS held including Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted for as derivatives		$	3,267,610		$	2,004		$	3,269,614
Total interest income including interest income on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted for as derivatives(1)		$	56,906		$	133		$	57,039
Yield on average amortized cost of RMBS including adjustments related to cost of Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted for as derivatives			2.75	%		10.49	%		2.76	%
Total interest expense including interest income (expense), net incurred on interest rate swaps(2)		$	14,416			—		$	14,416
Average cost of funds including interest income on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted for as derivatives			0.80	%		—			0.80	%
Net interest income including interest income on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps		$	42,490		$	133		$	42,623
Net interest rate spread including interest income on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps			1.95	%		10.49	%		1.96	%

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(1)

For the period from May 15, 2012 (commencement of operations) throughyear ended December 31, 20122013 includes net amortization(amortization of premiums,premiums), accretion of discounts and amortization(amortization/recovery of basisbasis) of approximately $(31.6)$(69.6) million. This amount is composed of approximately $(26.9)$(60.3) million for Agency RMBS included in interest income, approximately $0.1$8.3 million for Non-Agency RMBS included in interest income, approximately $(106) thousand for Agency and $(4.8)Non-Agency CMBS included in interest income, approximately $(9) thousand for Agency linked transactions (Non-GAAP measure), approximately $555 thousand for Non-Agency linked transactions (Non-GAAP measure) and approximately $(18.0) million of amortizationamortization/recovery of basis on Agency Interest-Only Strips and Agency Inverse Interest Non-Agency Interest—Only Strips accounted for as derivatives (Non-GAAP measure), not reported in interest income for GAAP (included in Loss on derivative instruments).



(2)

Represents the net amount paid, including accrued amounts, for interest rate swaps during the period, included in loss on derivative instruments for GAAP and interest expense on linked transactions.




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Period from May 15, 2012 (commencement of operations) through December 31, 2012 (dollars in thousands):

Non-GAAP Financial Measures:

		Agency			Non-agency			Total
Average amortized cost of RMBS held including Agency Interest—Only Strips accounted for as derivatives and linked transactions		$	3,267,610		$	2,004		$	3,269,614
Total interest income including interest income on Agency Interest—Only Strips accounted for as derivatives and linked transactions(1)		$	56,907		$	133		$	57,040
Yield on average amortized cost of RMBS including adjustments related to cost of Agency Interest—Only Strips accounted for as derivatives and linked transactions			2.75	%		10.49	%		2.76	%
Average balance of repurchase agreements		$	2,840,999			—		$	2,840,999
Total interest expense including interest income (expense), net incurred on interest rate swaps and interest expense incurred on linked transactions(2)		$	14,415			—		$	14,415
Average cost of funds including interest income (expense) on Agency Interest—Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions			0.80	%		—			0.80	%
Net interest income including interest income (expense) on Agency Interest—Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions		$	42,492		$	133		$	42,625
Net interest rate spread including interest income (expense) on Agency Interest—Only Strips accounted as derivatives and interest income (expense), net incurred on interest rate swaps and linked transactions			1.95	%		10.49	%		1.96	%

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(1)

For the period from May 15, 2012 (commencement of operations) through December 31, 2012 includes net (amortization of premiums), accretion of discounts and (amortization/recovery of basis) of approximately $(31.6) million. This amount is composed of approximately $(26.9) million for Agency RMBS included in interest income, approximately $123 thousand for Non-Agency included in interest income and approximately $(4.8) million of amortization/recovery of basis on Agency Interest—Only Strips accounted for as derivatives (Non-GAAP measure), not reported in interest income for GAAP (included in Loss on derivative instruments).



(2)

Represents the net amount paid, including accrued amounts and realized termination gain (loss), for interest rate swaps during the period, included in loss on derivative instruments for GAAP.

        Interest income is subject to interest rate risk. Refer to Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," for more information relating to interest rate risk and its impact on our operating results.




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Realized and Unrealized GainOther Income (Loss)

        DuringThe following tables present the period from May 15, 2012 (commencementsales of operations) through December 31, 2012, we soldour MBS (dollars in thousands):

		For the year ended December 31, 2013
		Proceeds			Gross Gains			Gross Losses			Net Gain (Loss)
Agency RMBS(1)		$	3,491,805		$	8,646		$	(127,252	)	$	(118,606	)
Non-Agency RMBS			128,683			7,146			(376	)		6,770
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	3,620,488		$	15,792		$	(127,628	)	$	(111,836	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

Includes proceeds for Agency RMBS and other securitiesInterest-Only Strips, accounted for as derivatives, of approximately $2.5 billion realizing gross gains of approximately $23.4$20.4 million and gross realized losses of approximately $3.4$1.1 million.

		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
		Proceeds			Gross Gains			Gross Losses			Net Gain (Loss)
Agency RMBS(1)		$	2,389,472		$	23,169		$	(3,434	)	$	19,735
Other Securities			100,854			199			—			199
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,490,326		$	23,368		$	(3,434	)	$	19,934
​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

Includes proceeds for Agency Interest-Only Strips, accounted for as derivatives, of approximately $18.5 million fromand gross realized losses of approximately $820 thousand.

        The MBS market remains a dynamic and, at times, volatile market. Our Manager is periodically reviewing the sale of securities. We sold these RMBS in order to: (i) adjust the prepayment characteristics of our portfolio; portfolio and may make changes to our portfolio in order to adjust such portfolio characteristics in response to and/or (ii)anticipation of changing market conditions. Accordingly, due to changes in market conditions or expected changes in market conditions, we sold these MBS in order to adjust the durationoverall characteristics of our portfolio.portfolio including, but not limited to, prepayment expectations and duration.

        With respect to our RMBS,MBS, we elected the fair value option and, as a result, we record the change in fair value related to RMBSMBS in earnings. The following table presentstables present amounts related to realized gains and losses as well as changes in fair value of our RMBSMBS portfolio and derivative instruments that are included in our statement of operations for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012 (dollars in thousands):




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For the Year ended December 31, 2013:

Description		Realized Gain (Loss), net			Contractual interest income (expense), net(1)			Other loss on Mortgage- backed securities			Unrealized Gain (Loss), net			Basis Recovery			Mark-to- market adjustments			Total
MBS and Other Securities		$	(110,712	)	$	—		$	(11,858	)	$	(160,109	)	$	—		$	—		$	(282,679	)
Cash and cash equivalents			—			91			—			—			—			—			91
Derivative Instruments:
Interest rate swaps			65,305			(22,932	)		—			—			—			83,764			126,137
Interest rate swaptions			23,671			—			—			—			—			4,733			28,404
Agency and Non-Agency Interest-Only Strips accounted for as derivatives			(1,124	)		28,273			—			—			(18,010	)		(700	)		8,439
Options			(925	)		—			—			—			—			—			(925	)
TBAs			(1,499	)		—			—			—			—			(3,009	)		(4,508	)
Linked Transactions			3,049			1,510			—			—			(366	)		(56	)		4,137
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	(22,235	)	$	6,942		$	(11,858	)	$	(160,109	)	$	(18,376	)	$	84,732		$	(120,904	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received. In addition, contractual interest income (expense), net on linked transactions includes amortization of approximately $9 thousand for Agency RMBS and accretion of approximately $921 thousand for Non-Agency RMBS.

Period from May 15, 2012 (commencement of operations) through December 31, 2012 (dollars in thousands):

Description		Realized Gain (Loss), net(1)			Contractual interest income (expense), net			Other loss on Residential mortgage- backed securities			Unrealized Gain (Loss), net			Mark-to- market adjustments			Total
RMBS and Other Securities		$	20,754		$	—		$	—		$	13,930		$	—		$	34,684
Agency IOs and IIOs			—			—			(3,206	)		—			—			(3,206	)
Derivative Instruments:
Interest rate swaps			(10,928	)		(6,321	)		—			—			7,649			(9,600	)
Interest rate swaptions															(3,180	)		(3,180	)
Agency Interest-Only Strips and Agency Inverse Interest-Only Strips—accounted for as derivatives			(820	)		8,570			—			—			(9,913	)		(2,163	)
TBAs			—			—			—			—			1,837			1,837
			(11,748	)		2,249			—			—			(3,607	)		(13,106	)
Total		$	9,006		$	2,249		$	(3,206	)	$	13,930		$	(3,607	)	$	18,372

Description		Realized Gain (Loss), net(1)			Contractual interest income (expense), net			Other loss on Residential mortgage- backed securities			Unrealized Gain (Loss), net			Basis Recovery			Mark-to- market adjustments			Total
RMBS and Other Securities		$	20,754		$	—		$	(3,206	)	$	13,930		$	—		$	—		$	31,478
Cash and cash equivalents			—			11			—			—			—			—			11
Derivative Instruments:
Interest rate swaps			(10,928	)		(6,321	)		—			—			—			7,649			(9,600	)
Interest rate swaptions			—			—			—			—			—			(3,180	)		(3,180	)
Agency Interest-Only Strips accounted for as derivatives			(820	)		8,570			—			—			(4,848	)		(5,065	)		(2,163	)
TBAs			—			—			—			—			—			1,837			1,837
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	9,006		$	2,260		$	(3,206	)	$	13,930			(4,848	)	$	1,241		$	18,383
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received.




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        In order to mitigate interest rate risk resulting from our future repurchase agreements,agreement borrowings, we entered into interest rate swaps with an aggregate notional amount of approximately $2.8 billion, of which $491.6 million are forward starting. Our effective swaps are comprised of approximately $2.2 billion fixed pays rate swaps and $127.0 million are variable pay swaps, which effectively fix (for the life of the swap) the floating interest rate of approximately $2.1 billion and interest rate swaptions with an aggregate notional amount of $520.0 million.approximately $2.1 billion at December 31, 2013. While not designated as a hedge for accounting purposes, our interest rate swaps and interest rate swaptions are viewed as an economic hedge on a portion of our floating-rate borrowingsborrowings. Since we do not apply hedge accounting for our interest rate swaps, and interest rate swaptions, we record the change in fair value related to such agreements in earnings as unrealized gain or loss(loss) on derivative instruments. Included in realized gain or loss on derivative instruments are the net interest rate swap payments (including accrued amounts) associated with our interest rate swaps.




Table For 2013, as yields on U.S. Treasuries increased, the value of Contentsinterest rate swaps increased which partially offset the realized and unrealized losses on our MBS portfolio.

Expenses

General and Administrative Expenses

        We incurred general and administrative expenses of approximately $6.4 million and $3.2 million for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively, which represents professional fees, insurance, non-cash stock based compensation and overhead costs of the Company.

Management Fee Expense

        We incurred management fee expense of approximately $7.8 million and $3.1 million for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively, of which approximately $1.9$1.8 million was payable at December 31, 20122013 to our Manager under the Management Agreement. Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5% per annum of our stockholders' equity (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears. Management fees primarily increased from 2013 over 2012 due to a follow-on public offering in October 2012 and a full year of operations in 2013.

        The management fees, expense reimbursements and the relationship between our Manager and us are discussed further in Note 8,9, "Related Party Transactions," to the financial statements contained in this Annual Report on Form 10-K.




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Dividends

        The following table presents cash dividends declared and paid by us on our common stock:

Declaration Date		Record Date		Payment Date		Amount per Share			Tax Characterization
2013
April 1, 2013		April 12, 2013		April 30, 2013		$	0.95		Ordinary income
June 20, 2013		July 1, 2013		July 29, 2013		$	0.90		Ordinary income
September 19, 2013		September 30, 2013		October 29, 2013		$	0.90		Ordinary income
December 19, 2013		December 30, 2013		January 28, 2014		$	2.35	(1)	Ordinary income
2012
July 26, 2012		August 6, 2012		August 14, 2012		$	0.38		Ordinary income
September 20, 2012		October 1, 2012		October 25, 2012		$	0.85		Ordinary income
December 19, 2012		December 31, 2012		January 29, 2013		$	1.12		Ordinary income

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Declaration Date		Record Date		Payment Date		Amount per Share
July 26, 2012		August 6, 2012		August 14, 2012		$	0.38
September 20, 2012		October 1, 2012		October 25, 2012		$	0.85
December 19, 2012		December 31, 2012		January 29, 2013		$	1.12

Subsequent Events

        On March 1, 2013,

(1)

Consisting of cash and stock. For stockholders who elected to receive the Company granted 10,559entire $2.35 per share dividend in stock, each stockholder received 0.1590 shares of restrictedin newly issued common stock for each common share that they held as of the dividend record date. For stockholders who elected to its chief financial officer underreceive the Equity Plan. One-third of these restricteddividend in cash, or did not make an election, each stockholder received $0.9159 per share in cash and 0.0970 shares vest on January 1, 2014, one-third vest on January 1, 2015 and the remaining one-third vest on January 1, 2016.

        On March 1, 2013, the Company granted 150,000 shares of restrictedin newly issued common stock to its Manager under the Manager Equity Plan. One-third of these restricted shares vest on March 1, 2014, one-third vest on March 1, 2015 and the remaining one-third vest on March 1, 2016.

        On April 1, 2013, we declared a dividend of $0.95 perfor each common share to shareholders of recordthat they held as of April 12, 2013 and payable on April 30, 2013.

the dividend record date.

Liquidity and Capital Resources

General

        Our liquidity and capital resources are managed on a daily basis to ensure that we have sufficient liquidity to absorb market events that could negatively impact collateral valuations and result in margin calls and to ensure that we have the flexibility to manage our investment portfolio to take advantage of market opportunities.




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        Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs. We use cash to purchase our target assets, repay principal and interest on our borrowings, make distributions to our stockholders and fund our operations.




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        Under our repurchase agreements and derivative contracts, lenders and counterparties retain the right to determine the fair value of the collateral pledged.pledged, or in the case of cleared swaps the required collateral may be determined by clearinghouse rules. A reduction in the value of the collateral pledged will require us to provide additional collateral or fund cash margin calls. Additionally,Alternatively, since margins calls for our interest rate swaps and swaptions generally are inversely correlated to those of our repurchase agreements, whereby our interest rate swap and swaptions counterparties would likely be required to post collateral with us.us during a period in which we were required to post collateral with our repurchase agreement counterparties. During 2013, the fixed income markets experienced volatility and, in particular, the sell-off in Agency RMBS that occurred between the beginning of July 2013 and the Federal Reserve announcing its decision not to taper for the time being on September 18, 2013, resulted in demands for additional collateral from our repurchase agreement counterparties. Similarly, we received incremental collateral from our interest rate swap and swaption counterparties during this time. We were able to satisfy our additional collateral requirements with unpledged securities in our portfolio, cash on hand and cash received as and with respect to incremental collateral received on our interest rate swaps and swaptions. We were not forced to involuntarily sell any of our assets, nor did any of counterparties sell any of assets held by them as collateral. During the second and third quarters of 2013, we rehypothecated some of the securities we received as incremental collateral on our swaps and swaptions, effectively entering into repurchase agreements with such securities, in order to increase our cash position. The maximum amount of repurchase borrowings for the rehypothecated securities was $130.7 million during the year ended December 31, 2013. At December 31, 2013, no securities were rehypothecated. In an instance of severe volatility, or where the additional stress on liquidity resulting from volatility is sustained over an extended period of time, we could be required to sell securities, possibly even at a loss to generate sufficient liquidity to satisfy collateral and margin requirements which could have a material adverse effect on our financial position, results of operations and cash flows.

        As part of our risk management process, our Manager closely monitors our liquidity position including developingposition. This includes the development and evaluation of various alternative processes and procedures, which continue to be updated with regard to scenario testing for purposes of assessing our liquidity in the face of different economic and market developments. We believe we have sufficient current liquidity and access to additional liquidity to meet financial obligations for at least the next 12 months.

        Our primary sources of liquidity are as follows:

Cash Generated from Initial Public Offering, Concurrent Private Placements and Follow-On Public Offering

        On May 15, 2012, we completed our IPO and concurrent private placements generating net proceeds of approximately $204.4 million. On October 3, 2012, we completed a follow-on public offering generating net proceeds of approximately $301.0 million.




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Borrowing under Various Financing Arrangements

        As of December 31, 2012,2013, we had master repurchase agreements with 14 counterparties and are in discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.20 counterparties. We had borrowings under repurchase agreements with 1416 counterparties of approximately $4.8$2.6 billion at December 31, 2012.2013. The following tables present our borrowings by type of collateral pledged as of December 31, 2013 and December 31, 2012, and the respective effective cost of funds (non-GAAP(Non-GAAP financial measure) for the period thenyear ended December 31, 2013 (dollars in thousands) and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively. See "Non-GAAP Financial Measures" (dollars in thousands):

Collateral		Principal Balance			Fair Value of Collateral Pledged(1)			Weighted Average Interest Rate, end of period			Weighted Average Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012			Weighted Average Effective Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012(2)
Agency RMBS		$	4,794,730		$	5,079,806			0.48	%		0.45	%		0.80	%
Total		$	4,794,730		$	5,079,806			0.48	%		0.45	%		0.80	%

Collateral		Repurchase Agreement Borrowings Outstanding December 31, 2013			Fair Value of Collateral Pledged(1)			Weighted Average Interest Rate end of period			Weighted Average Cost of Funds for the year ended December 31, 2013			Weighted Average Effective Cost of Funds (Non- GAAP) for the for the year ended December 31, 2013(2)
Agency RMBS		$	2,331,276		$	2,463,347			0.43	%		0.43	%		1.05	%
Non-Agency RMBS			230,247			332,003			1.71			1.77			1.77
Agency and Non-Agency CMBS			17,544			23,597			1.33			1.39			1.39
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Excluding Linked Transactions		$	2,579,067		$	2,818,947			0.55	%		0.47	%		1.08	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Agency RMBS Linked Transactions			—			—			n/a			n/a			0.38
Non-Agency RMBS Linked Transactions			61,187			79,746			1.70			n/a			1.78
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total (Non-GAAP)		$	2,640,254		$	2,898,693			0.54	%		0.47	%		1.08	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

IncludesExcludes approximately $32.6 million of cash collateral posted.



(2)

The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net payments on interest rate swaps of approximately $22.9 million and interest expense on linked transactions of approximately $271 thousand. While interest rate swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates on our liabilities and are treated as hedges for purposes of satisfying the REIT tax requirements. See "Non-GAAP Financial Measures".

Collateral		Repurchase Agreement Borrowings Outstanding December 31, 2012			Fair Value of Collateral Pledged(1)			Weighted Average Interest Rate end of period			Weighted Average Cost of Funds for the period from May 15, 2012 (commencement of operations) through December 31, 2012			Weighted Average Effective Cost of Funds (Non- GAAP) for the period from May 15, 2012 (commencement of operations) through December 31, 2012(2)
Agency RMBS		$	4,794,730		$	5,043,824			0.48	%		0.45	%		0.80	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total (Non-GAAP)		$	4,794,730		$	5,043,824			0.48	%		0.45	%		0.80	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

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(1)

Excludes approximately $36.0 million of cash collateral for Agency RMBS.



(2)

The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net payments on interest rate swaps of approximately $6.3 million. While interest rate swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates on our liabilities and are treated as hedges for purposes of satisfying the REIT tax requirements. See "Non-GAAP Financial Measures".




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        As of December 31, 2012,2013, our transactions under repurchase agreements with 1420 counterparties for Agency RMBS,MBS, require collateral in excess of the loan amount, or haircuts, ranging from a low of 3%3.0% to a high of 7%,5.5% for Agency RMBS, exclusive of IOs and IIOs for which the haircuts are as high as 25%30.0% and for Non-Agency RMBS and Agency and Non-Agency CMBS for which the haircuts range from a low of 10.0% to a high of 45.0%. Declines in the value of our Agency RMBS portfolio can trigger margin calls by our lenders under our repurchase agreements. Margin calls could adversely affect our liquidity. Our inability to post adequate collateral for a margin call by the counterparty could result in a condition of default under our repurchase agreements. An event of default or termination event would give some of our counterparties the option to terminate all existing repurchase transactions with us and require any amount due to the counterparties by us to be payable immediately. In which case, we may be forced to sell assets under adverse market conditions or through foreclosure.foreclosure which may have a material adverse consequence on our business, financial position, our results of operations and cash flows. During the year ended December 31, 2013, we received a number of margin calls which we satisfied using cash on hand, unlevered or underleveraged securities, securities received as collateral on our repurchase agreements and derivative positions and cash received from the rehypothecation of collateral received. No event of default occurred.

        Under the repurchase agreements and derivative contracts, the respective lenders and counterparties, subject to the terms of the individual agreements and in the case of cleared swaps, the clearinghouse rules, retain the right to determine the fair value of the underlying collateral. A reduction in the value of pledged assets requires us to provide additional collateral or fund margin calls. In addition, certain of the repurchase agreements may be terminated by our counterparties if we do not maintain certain equity and leverage metrics. We were not aware of any failure to meetare compliant with these tests at December 31, 2012. RMBS2013. At December 31, 2013, MBS held by counterparties as security for repurchase agreements totaled approximately $5.0$2.9 billion, inclusive of MBS posted of $79.7 million for repurchase agreements accounted for as linked transactions. At December 31, 2012, MBS held by counterparties as security for repurchase agreements totaled approximately $5.1 billion.

        We are also required to pledge cash or securities as collateral as part of a margin arrangement, calculated daily, in connection with the swaps.swaps and swaptions. The amount of margin that we are required to post will vary by counterparty and generally reflects collateral posted with respect to swaps that are in an unrealized loss position to us and a percentage of the aggregate notional amount of swaps per counterparty. Margin calls could adversely affectcounterparty as well as margin posted with our liquidity. Our inabilityclearing broker, pursuant to post adequate collateralclearinghouse rules and practices, for a margin call by the counterparty could result in a condition of default under our repurchase agreements, thereby enabling the counterparty to liquidate the collateral pledged by us, which may have a material adverse consequence on our business and results of operations.cleared swaps. Conversely, if our bilateral swaps and swaptions are in an unrealized gain position, our counterparties are required to post collateral with us, under the same terms that we post collateral with them.

        Cash collateral held by counterparties at December 31, 2013 was approximately $55.4 million, which is included in Due from counterparties on our Balance Sheet, comprised of approximately $32.6 million held in connection with repurchase borrowings and approximately $22.8 million held by our interest rate swap counterparties. At December 31, 2013, Due to counterparties on our Balance Sheet was comprised of approximately $3.2 million posted with us by our repurchase agreement counterparties and approximately $62.7 million posted by our interest rate swap and swaption counterparties. Cash collateral held by counterparties at December 31, 2012 was approximately $54.1 million, which is included in Due from counterparties on our balance sheet, comprised of approximately $36.0 million held in connection with repurchase borrowings and approximately $18.1 million held by our interest rate swap and interest rate swaption counterparties. In addition, at December 31, 2013, and December 31, 2012, we held securities of approximately $0, and $2.6 million, respectively, received as collateral from our repurchase agreement counterparties to satisfy margin requirements.

        We had no unsettled purchased securities as of December 31, 2013 and December 31, 2012, included in Investment related payables on our Balance Sheet. In addition, we had no unsettled sold securities as of December 31, 2013 and December 31, 2012, included in Investment related receivables on our Balance Sheet.




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Cash Generated from Operations

        OurFor the year ended December 31, 2013, operating activities provided netincreased our cash ofbalance by approximately $33.5 million for the period from May 15, 2012 (commencement of operations) through December 31, 2012. The cash provided by operating activities$179.3 million. This was primarily a result of ourattributable to the net interest income we earned on our investments for the year net of adjustments pertaining to the amortization/accretion of premiums and discounts, which is interest income less interest expense during our initial period of operation. Our net income forare non-cash items. For the period from May 15, 2012 (commencement of operations) through December 31, 2012, operating activities increased our cash balance by approximately $33.5 million. This was attributable to the net interest income we earned on our investments, offset by an increase in accrued interest receivable and adjustments pertaining to the amortization/accretion of premiums and discounts, which are non-cash items.

Cash Provided by and Used in Investing Activities

        For the year ended December 31, 2013, our investing activities increased our cash balance by approximately $57.3 million. Included in$2.0 billion. This was primarily attributable to our net income forreceipt of principal payments on MBS and proceeds received from sales of MBS, reduced by our purchases of MBS. For the period from May 15, 2012 (commencement of operations) through December 31, 2012, were non-cash items that do not affectinvesting activities decreased our cash such as amortizationbalance by approximately $5.2 billion. This was primarily attributable to our cash expenditures to acquire MBS, offset by proceeds from sales of MBS.

Cash Provided by and Used in Financing Activities

        For the premium and accretion ofyear ended December 31, 2013, our financing activities decreased our cash balance by approximately $2.2 billion. This was primarily attributable to the discount ondecrease in our RMBS, unrealized gain/(loss) on securities, mark-to-market adjustments on derivatives and other losses on residential mortgage-backed securities. Also included in net income forborrowings under repurchase agreements from approximately $4.8 billion at December 31, 2012 to approximately $2.6 billion at December 31, 2013. For the period from May 15, 2012 (commencement of operations) through December 31, 2012, werefinancing activities increased our cash balance by approximately $5.2 billion. This was primarily attributable to an increase in our net realized gains of approximately $20.8 million which isborrowings under repurchase agreements and the cash generated from investing activities. During the same period, cash from operations of approximately $8.1 million was used to increase our net operating assets over operating liabilities.




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Cash Used in Investing Activities

        Our investing activities used net cash of approximately $5.2 billion for the period from May 15, 2012 (commencement of operations) through December 31, 2012. During the period from May 15, 2012 (commencement of operations) through December 31, 2012, we utilized cash to purchase approximately $7.8 billion of RMBSinitial public offering, concurrent private placements and other securities, which was offset by proceeds from asset sales of approximately $2.5 billion and principal payments and basis recovered of approximately $105.7 million.follow-on public offering.

Other Potential Sources of Financing

        We held cash of approximately $48.5 million and $56.3 million at December 31, 2012.2013 and 2012, respectively. Our primary sources of cash currently consist of repurchase facility borrowings, investment income and the proceeds of our follow-on public offering.any future securities offering, to the extent available in the capital market. In the future, we expect our primary sources of liquidity to consist of payments of principal and interest we receive on our portfolio of assets, unused borrowing capacity under our financing sources and future issuances of equity and debt securities.

        To maintain our qualification as a REIT under the Code, we must distribute annually at least 90% of our taxable income. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital for operations. We believe that our significant capital resources and access to financing will provide us with financial flexibility at levels sufficient to meet current and anticipated capital requirements, including funding new investment opportunities, paying distributions to our stockholders and servicing our debt obligations.




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Contractual Obligations and Commitments

        Our contractual obligations as of December 31, 20122013 are as follows (dollars in thousands):

		Less than 1 year			1 to 3 years			3 to 5 years			More than 5 years			Total
Borrowings under repurchase agreements		$	4,794,730			—			—			—		$	4,794,730
TBA—long positions			443,883			—			—			—			443,883
Total		$	5,238,613			—			—			—		$	5,238,613

		Less than 1 year			1 to 3 years			3 to 5 years			More than 5 years			Total
Borrowings under repurchase agreements (including linked transactions)		$	2,640,254			—			—			—		$	2,640,254
TBA—long positions			199,585			—			—			—			199,585
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: Non-GAAP Basis—Including Linked Transactions			2,839,839			—			—			—			2,839,839
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Linked Transactions			61,187			—			—			—			61,187
TBA—long positions			199,585			—			—			—			199,585
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total: GAAP Basis—Excluding Linked Transactions and TBA—long positions		$	2,579,067			—			—			—		$	2,579,067
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

        We enter into a linked transaction when the initial transfer of a financial asset and repurchase financing are entered into contemporaneously with, or in contemplation of, one another. In this situation, we then record the initial transfer and repurchase financing on a net basis. The fair value of linked transactions reflects the value of the underlying real estate securities and linked repurchase agreement borrowings; resulting in an embedded repurchase agreement. As of December 31, 2013, we had 19 linked transactions resulting in approximately $61.2 million of embedded repurchase agreements with a weighted average rate of 1.7%. The weighted average contractual maturity of the repurchase agreements for linked transactions was 63 days.

        As of December 31, 2012,2013, we have an obligation for approximately $4.7$2.9 million in contractual interest payments related to our repurchase agreements, including linked transactions of approximately $187 thousand through the respective maturity date of each repurchase agreement.

        The table above does not include amounts due under the Management Agreement (as defined herein) with our Manager, as those obligations do not have fixed and determinable payments. For a description of the Management Agreement, see "Our Manager and the Management Agreement—the Management Agreement."




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        On May 9, 2012, we entered into a management agreement (the "Management Agreement") with our Manager pursuantwhich describes the services to whichbe provided by our Manager is entitled to receive a management fee and reimbursement of certain expenses.compensation for such services. Our Manager is responsible for:for managing our operations, including: (i) performing all of our day-to-day functions, other than those provided by our chief financial officer;functions; (ii) determining investment criteria in conjunction with our board of directors; (iii) sourcing, analyzing and executing investments, asset sales and financings; (iv) performing asset management duties; and (v) performing financial and accounting management, subject to the direction and oversight of our board of directors. Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5%1.50% per annum of our stockholders' equity, (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears. For purposes of calculating the management fee, "stockholders' equity" means the sum of the net proceeds from any issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings, calculated in accordance with GAAP, at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid for repurchases of our shares of common stock, excluding any unrealized gains, losses or other non-cash items, including OTTI charges included in other loss on MBS, unrealized gain (loss) on MBS and other securities and the non-cash portion of gain (loss) on derivative instruments, that have impacted stockholders' equity as reported in our financial statements prepared in accordance with GAAP, regardless of whether such items are included in other comprehensive income or loss, or in net income, and excluding one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between our Manager and our independent directors and after approval by a majority of our independent directors. However, if our stockholders' equity for any given quarter is negative based on the calculation described above, our Manager will not be entitled to receive any management fee for that quarter.

        In addition, under the Management Agreement, we are required to reimburse our Manager for the expenses described below. Expense reimbursements to the Manager are made in cash on a monthly basis following the end of each month. Our reimbursement obligation is not subject to any dollar limitation. Because our Manager's personnel perform certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, our Manager ismay be paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis. For the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, our Manager did not request any such reimbursements, exclusive of certain salary or employee benefits associated with our sole employee.employee, and certain de-minimis expenses paid by our Manager on our behalf. Commencing January 1, 2014, our chief financial officer is now an employee of the Manager. Accordingly, we will reimburse our Manager for his compensation and benefits.

        The Management Agreement may be amended, supplemented or modified by agreement between our Manager and us. The initial term of the Management Agreement expires on May 15, 2015 and it is automatically renewed for one-year terms on each anniversary thereafter unless previously terminated as described below. Our independent directors will review the Manager's performance and any fees payable to the Manager annually and, following the initial term, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds (²/3)(2/3) of our independent directors, based upon: (i) our Manager's unsatisfactory performance that is materially detrimental to us; or (ii) our determination that any fees payable to our Manager are not fair, subject to our Manager's right to prevent such termination due to unfair fees by accepting a reduction of management fees agreed to by at least two-thirds (²/3)(2/3) of our independent directors. We will provide our Manager 180 days prior notice of any such termination. Unless terminated for cause, we will pay the Manager a termination fee equal to three times the average annual management fee earned by the Manager during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.




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        We may also terminate the Management Agreement at any time, including during the initial term, without the payment of any termination fee, with 30 days prior written notice from our board of directors for cause, which will be determined by a majority of our independent directors, which is defined as: (i) our Manager's continued material breach of any provision of the Management Agreement (including our Manager's failure to comply with our investment guidelines); (ii) our Manager's fraud, misappropriation of funds, or embezzlement against us; (iii) the Manager's gross negligence in the performance of its duties under the Management Agreement; (iv) the occurrence of certain events with respect to the bankruptcy or insolvency of our Manager, including an order for relief in an involuntary bankruptcy case or our Manager authorizing or filing a voluntary bankruptcy petition; (v) our Manager is convicted (including a plea of nolo contendere) of a felony; or (vi) the dissolution of our Manager.

Off-Balance Sheet Arrangements

        Our linked transactions are comprised of real estate securities and associated repurchase agreements. The extent to which these transactions become unlinked in the future, the underlying real estate securities and the borrowings under repurchase agreements and associated interest income and expense will be presented on a gross basis on our balance sheet and statement of operations, prospectively. As of December 31, 2013, our maximum exposure to loss on linked transactions was approximately $18.6 million.

        As of December 31, 2013, we held contracts to purchase ("long position") and sell ("short position") TBAs on a forward basis. If a counterparty to one of the TBAs that we enter into defaults on its obligations, we may not receive payments or securities due under the TBA agreement, and thus, we may lose any unrealized gain associated with that TBA transaction.

We do not have any relationships with any entities or financial partnerships, such as entities often referred to as structured investment vehicles, or special purpose or variable interest entities, established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes.

        Further, we have not guaranteed any obligations of any entities or entered into any commitment to provide additional funding to any such entities.

        See "Warrants" above for a description of our outstanding warrants.

Dividends

        We intend to make regular quarterly dividend distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT distribute annually, in accordance with the REIT regulations, at least 90% of its REIT taxable income for the taxable year, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually, in accordance with the REIT regulations, distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our stockholders based on our net taxable income, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debts payable. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.




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        On December 19, 2013, we declared a dividend of $2.35 per common share payable in a combination of cash and stock. For stockholders who elected to receive the entire $2.35 per share dividend in stock, each stockholder received 0.1590 shares in newly issued common stock for each common share that they held as of the dividend record date. For stockholders who elected to receive the dividend in cash, or did not make an election, each stockholder received $0.9159 per share in cash and 0.0970 shares in newly issued common stock for each common share that they held as of the dividend record date. The dividend was paid on January 28, 2014 to shareholders of record as of December 30, 2013. As a result a portion of the dividend being paid in stock, we issued 2,548,784 shares of common stock.

Non-GAAP Financial Measures

Total Interest Income and Net Interest Income, including Interest Income on Agency Interest-Only and Agency Inverse Interest-Only Strips accounted for as derivatives and Effective Cost of Funds

        Total interest income including interest income on Agency Interest-Only Strips and Agency Inverse Interest-Only Strips classified as derivatives and Effective Cost of Funds for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, constitutes a non-GAAPNon-GAAP financial measure within the meaning of Regulation G promulgated by the SEC. We believe that the measures presented in this annual report on Form 10-K, when considered together with U.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and net interest income, as viewed by us. An analysis of any non-GAAPNon-GAAP financial measure should be made in conjunction with results presented in accordance with GAAP.

        For purposes of evaluating operating results, we believe it useful to present investors with additional information pertaining to the net interest margin generated by our portfolio. Net interest margin is gross interest, adjusted for amortization/accretion of bond premium/discount, less interest expense or financing cost. GAAP requires that certain of our IO and IIO securities be treated as derivatives and, accordingly, the interest income associated with these securities be included with Gain (loss) on derivative instruments, net in our Statement of Operations. Similarly, GAAP requires that interest income on linked transactions be included in Gain (loss) on linked transactions, net in our Statement of Operations. Accordingly, in order to determine the gross interest income generated by our IO and IIO securities which are classified as derivatives and our MBS securities which are classified as linked transactions, we calculate the interest income on these securities as if they were not derivatives or linked transactions.




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        The following table reconciles total interest income to interest income including interest income on Agency Interest-Only and Non- Agency Inverse Interest-Only Strips classified as derivatives and interest income on linked transactions (Non-GAAP financial measure) for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012:

(in thousands)		For the Year ended December 31, 2013			For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Coupon Interest		$	177,472		$	80,103
Premium accretion, discount amortization and amortization of basis, net			(52,144	)		(26,785	)
​	​	​	​	​	​	​	​
Interest Income		$	125,328		$	53,318
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​
Contractual Interest income, net of amortization basis on Agency and Non-Agency Interest-Only and Interest Strips, classified as derivatives(1) :
Coupon Interest		$	28,273		$	8,570
Amortization of basis (Non-GAAP Financial Measure)			(18,010	)		(4,848	)
Contractual Interest income, net of discount amortization on Linked Transactions(2):
Coupon Interest			869			—
Discount amortization			546			—
​	​	​	​	​	​	​	​
Subtotal			11,678			3,722
​	​	​	​	​	​	​	​
Total interest income, including interest income on Agency and Non-Agency Interest-Only Strips, classified as derivatives—Non-GAAP Financial Measure		$	137,006		$	57,040
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​

(in thousands)		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Coupon Interest		$	80,103
Premium accretion, discount amortization and amortization of basis, net			(26,785	)
Interest Income		$	53,318
Contractual Interest income, net of amortization basis on Agency Interest-Only and Interest Strips, classified as derivatives(1):
Coupon Interest		$	8,570
Amortization of basis (Non-GAAP Financial Measure)			(4,849	)
Subtotal			3,721
Total interest income, including interest income on Agency Interest-Only Strips, classified as derivatives—Non-GAAP Financial Measure		$	57,039

---

(1)

Reported in Lossgain (loss) on derivative instruments in the Statement of Operations.



(2)

Reported in gain (loss) on linked transactions in the Statement of Operations.

        Effective Cost of Funds includes the net interest component related to our interest rate swaps.swaps and borrowings under linked transactions. While we have not elected hedge accounting for our interest rate swaps, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates on our liabilities and are characterized as hedges for purposes of satisfying the REIT tax requirements and therefore the Effective Cost of Funds reflects interest expense adjusted to include the realized loss (i.e., the interest expense component) for all of our interest rate swaps. In addition, our linked transactions are comprised of real estate securities, associated with repurchase agreements. We view the cost of the associated repurchase agreements (interest expense) as a component of our Effective Cost of Funds.




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        The following table reconciles the Effective Cost of Funds (non-GAAP(Non-GAAP financial measure) with interest expense for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012:

        Period from May 15, 2012 (commencement of operations) through December 31, 2012:

		For the year ended December 31, 2013						For the period from May 15, 2012 (commencement of operations) through December 31, 2012
(dollars in thousands)		Reconciliation			Cost of Funds/Effective Borrowing Costs			Reconciliation			Cost of Funds/Effective Borrowing Costs
Interest expense		$	18,019			0.47	%	$	8,094			0.45	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Interest expense on linked transactions			271			1.65	%		—			—
Net interest paid—interest rate swaps			22,932			0.61	%		6,321			0.35	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Effective Borrowing Costs		$	41,222			1.08	%	$	14,415			0.80	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Weighted average repurchase borrowings(1)			3,821,925						2,840,999

---

(dollars in thousands)		Reconciliation			Cost of Funds/ Effective Borrowing Costs
Interest expense		$	8,094			0.45	%
Net interest paid—interest rate swaps			6,322			0.35	%
Effective Borrowing Costs		$	14,416			0.80	%
Weighted average repurchase borrowings			2,840,999

(1)

Includes average repurchase borrowings under linked transactions.




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Core Earnings

        Our Core Earnings were approximately $82.7 million and approximately $36.7 million for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012,

        Our Core Earnings were approximately $36.7 million for the period from May 15, 2012 (commencement of operations) through December 31, 2012. respectively. Core Earnings is a non-GAAPNon-GAAP financial measure that is used by us to approximate cash available for distributionyield or income associated with our portfolio and is defined as GAAP net income (loss) as adjusted, excluding: (i) net realized gain (loss) on investments and derivative contracts; (ii) net unrealized gain (loss) on investments; (iii) lossnet gain (loss) resulting from mark-to-market adjustments on derivative contracts; (iv) other loss on RMBSMBS; (v) non-cash stock-based compensation expense; and (vi) one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the us, the Manager and our independent directors and after approval by a majority of the our independent directors.

        In order to evaluate the effective yield of the portfolio, we use Core Earnings to reflect the net investment income of our portfolio as adjusted to reflect the net interest rate swap interest income (expense). Core Earnings allows us to isolate the interest income (expense) associated with our interest rate swaps in order to monitor and project our borrowing costs and interest rate spread. In addition, we utilize Core Earnings as a key metric in conjunction with other portfolio and market factors to determine the appropriate leverage and hedge ratios, as well as the overall structure of the portfolio. We also believe that our investors use Core Earnings or a comparable supplemental performance measure to evaluate and compare our performance and our peers, and as such, we believe that the disclosure of Core Earnings is useful to our investors.

        Our presentation of Core Earnings may not be comparable to similarly-titled measures of other companies, who may use different calculations. As a result, Core Earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP.




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        The table below summarizes the reconciliation fromreconciles Net Income (loss) to Core Earnings for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012:

(dollars in thousands)		For the period from May 15, 2012 (commencement of operations) through December 31, 2012				For the year ended December 31, 2013			For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Net Income—GAAP		$	57,277
Net Income (loss)—GAAP						$	(27,855	)	$	57,277
Adjustments:
RMBS and other securities:
Unrealized gain on RMBS			(13,930	)
Other loss on Residential mortgage-backed securities			3,206
Realized gain on sale of RMBS			(20,754	)
MBS and other securities:
Unrealized (gain) loss on MBS							160,109			(13,930	)
Other loss on mortgage-backed securities							11,858			3,206
Realized (gain) loss on sale of MBS							110,712			(20,754	)
Derivative Instruments:
Realized loss on termination of interest rate swaps			10,928
Realized (gain) loss on termination of interest rate swaps							(65,305	)		10,928
Realized loss on settlement of TBAs							1,499			—
Realized loss on expiration of option derivatives							925			—
Realized gain on sale of swaptions							(23,671	)		—
Realized gain on sale of securities underlying linked transactions							(3,049	)		—
Realized loss on Agency Interest-Only Strips—accounted for as derivatives							1,124			820
Mark-to- market adjustments on interest rate swaps			(7,649	)			(83,764	)		(7,649	)
Mark-to- market adjustments on interest rate swaptions			3,180				(4,733	)		3,180
Mark-to- market adjustments on TBAs			(1,837	)			3,009			(1,837	)
Mark-to-market adjustments on linked transactions							56			—
Mark-to-market adjustments on derivative instruments			9,913				700			5,065
Basis amortization of Agency Interest-Only Strips—accounted for as derivatives			(4,848	)
Realized loss on Agency Interest-Only Strips—accounted for as derivatives			820
Non-cash stock-based compensation expense			367				1,087			367
​					​		​	​		​	​
Total adjustments			(20,604	)			110,557			(20,604	)
​					​		​	​		​	​
Core Earnings—Non-GAAP Financial Measure		$	36,673			$	82,702		$	36,673
​					​		​	​		​	​
​					​		​	​		​	​
Basic Core Earnings per Share of Common Stock and Participating Securities—Non-GAAP Financial Measure		$	2.33			$	3.39		$	2.33
Diluted Core Earnings per Share of Common Stock and Participating Securities—Non-GAAP Financial Measure		$	2.32			$	3.38		$	2.32
​					​		​	​		​	​
​					​		​	​		​	​
Basic weighted average common shares and participating securities			15,718,711				24,374,025			15,718,711
Diluted weighted average common shares and participating securities			15,783,491				24,454,716			15,783,491
​					​		​	​		​	​
​					​		​	​		​	​




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Revision of        Alternatively, our Core Earnings forcan also be derived as presented in the period from May 15, 2012 (commencement of operations) through June 30, 2012 and for the quarter ended September 30, 2012.

        In a press release issued on April 2, 2013, we announced that during the process of preparing our 2012 financial statements, we discovered the methodology used to accretetable below by starting with Net interest income and to amortize the cost basis of certain of the our residential mortgage backed securities, which was based on a third party vendor's system, as well as the presentation with regard to certain items in our Statement of Cash Flows were not in accordance with GAAP. The resulting correction of these errors resulted in a reclassification of a portion of our previously reported netincluding interest income to realizedon Interest-Only Strips accounted for as derivatives and unrealized gainsinterest income (expense), net incurred on interest rate swaps (a Non-GAAP financial measure) subtracting Operating Expenses, net of Non-cash stock based compensation, and as a result this impacted our previously reported Core Earnings for the period from May 15, 2012 (commencement of operations) through June 30, 2012 and the quarter ended September 30, 2012. Core Earnings for the period from May 15, 2012 (commencement of operations) through June 30, 2012 increased from approximately $4.8 million or $0.47 per fully diluted share to approximately $5.5 million or $0.53 per fully diluted share. For the quarter ended September 30, 2012, Core Earnings decreased from approximately $9.3 million or $0.89 per fully diluted share to approximately $8.2 million or $0.79 per fully diluted share.

        The tables below summarize the reconciliation from Net Income to Core Earnings for the period from May 15, 2012 (commencement of operations) through June 30, 2012 and the quarter ended September 30, 2012, as revised.adding Interest income on cash balances:

		For the period from May 15, 2012 (commencement of operations) through June 30, 2012									Quarter Ended September 30, 2012
(dollars in thousands)		As Originally Reported			Adjustments			As revised			As Originally Reported			Adjustments			As revised
Net Income—GAAP		$	4,261		$	—		$	4,261		$	28,194		$	—		$	28,194
Adjustments:
RMBS and other securities:
Unrealized gain on RMBS			(3,925	)		942			(2,983	)		(28,329	)		2,104			(26,225	)
Other loss on Residential mortgage-backed securities			605			(518	)		87			5,545			(4,193	)		1,352
Realized gain on sale of RMBS			(1,120	)		(37	)		(1,157	)		(6,454	)		(181	)		(6,635	)
Derivative Instruments:
Realized loss on termination of interest rate swaps			—			(4	)		(4	)		—			—			—
Mark-to- market adjustments on interest rate swaps			4,968			76			5,044			8,075			—			8,075
Mark-to- market adjustments on interest rate swaptions			—			—			—			298			—			298
Mark-to- market adjustments on TBAs			—			—			—			—			—			—
Mark-to-market adjustments on derivative instruments			—			347			347			1,786			3,075			4,861
Basis amortization of Agency Interest-Only Strips—accounted for as derivatives			—			(122	)		(122	)		—			(1,888	)		(1,888	)
Realized loss on Agency Interest-Only Strips—accounted for as derivatives			—			—			—			—			—			—
Non-cash stock-based compensation expense			54			—			54			157			—			157
Total adjustments			582			684			1,266			(18,922	)		(1,083	)		(20,005	)
Core Earnings—Non-GAAP Financial Measure		$	4,843		$	684		$	5,527		$	9,272		$	(1,083	)	$	8,189
Basic Core Earnings per Share of Common Stock and Participating Securities—Non-GAAP Financial Measure		$	0.47		$	0.06		$	0.53		$	0.90		$	(0.11	)	$	0.79
Diluted Core Earnings per Share of Common Stock and Participating Securities—Non-GAAP Financial Measure		$	0.47		$	0.06		$	0.53		$	0.89		$	(0.10	)	$	0.79
Basic weighted average common shares and participating securities			10,334,824			10,334,824			10,334,824			10,343,944			10,343,944			10,343,944
Diluted weighted average common shares and participating securities			10,334,824			10,334,824			10,334,824			10,364,252			10,364,252			10,364,252

(dollars in thousands)		For the year ended December 31, 2013			For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Net interest income including interest income on Interest-Only Strips accounted for as derivatives and interest income (expense), net incurred on interest rate swaps (a Non-GAAP financial measure)		$	95,784		$	42,625
Total Operating Expenses			(14,260	)		(6,330	)
Non-cash stock based compensation			1,087			367
Interest income on cash balances			91			11
​	​	​	​	​	​	​	​
Core Earnings (a Non-GAAP) financial measure		$	82,702		$	36,673
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​




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ITEM 7A.    Quantitative and Qualitative Disclosures about Market Risk.


        We seek to manage the risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market values while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns from our assets through ownership of our common stock. While we do not seek to avoid risk completely, our Manager seeks to actively manage risk for us, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

Credit Risk

        We are subject to varying degrees of credit risk in connection with our assets. Although we do not expect to encounter credit risk in our Agency RMBS,MBS, we do expect to encounter credit risk related to Non-Agency RMBSMBS and any of our other target assets we may acquire.Non-Agency CMBS. Investment decisions are made following a bottom-up credit analysis and specific risk assumptions. As part of the risk management process, our Manager uses detailed proprietary models to evaluate, depending on the asset class, house price appreciation and depreciation by region, prepayment speeds and foreclosure frequency, cost and timing. If our Manager determines that the proposed investment can meet the appropriate risk and return criteria as well as complement our existing asset portfolio, the investment will undergo a more thorough analysis.

        As of December 31, 2013, 15 of the counterparties that we had outstanding repurchase agreement borrowings withheld collateral which we posted as security for such borrowings in excess of 5% of our Stockholders' equity. Prior to entering into a repurchase agreement with any particular institution, our Manager does a thorough review of such potential counterparty. Such review, however, does not assure the creditworthiness of such counterparty nor that the financial wherewithal of the counterparty will not deteriorate in the future.




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Interest Rate Risk

        Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to finance the acquisition of our assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances in addition to transaction or asset specific funding arrangements. Subject to maintaining our qualification as a REIT for U.S. federal income tax purposes, we utilize derivative financial instruments to hedge the interest rate risk associated with our borrowings. We also may engage in a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.

Interest Rate Effect on Net Interest Income

        Our operating results will depend in large part on differences between the income earned on our assets and our borrowing costs. The cost of our borrowings is generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase and the yields earned on our leveraged fixed ratefixed-rate mortgage assets will remain static. Further, the cost of such financing could increase at a faster pace than the yields earned on our leveraged ARM and hybrid ARM assets, if any.assets. This could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our assets. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.




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Interest Rate Cap Risk

        IfTo the extent we elect to invest in adjustable-rate RMBS, such securities are generally subject to interest rate caps, which potentially could cause such RMBS to acquire many of the characteristics of fixed-rate securities if interest rates were to rise above the cap levels. This issue is magnified to the extent we acquire ARM and hybrid ARM assets that are not based on mortgages which are fully indexed. In addition, ARM and hybrid ARM assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding or a portion of the incremental interest rate increase being deferred. To the extent we invest in such ARM and/or hybrid ARM assets, we could potentially receive less cash income on such assets than we would need to pay the interest cost on our related borrowings. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above under "—Interest Rate Risk."

Interest Rate Effects on Fair value

        Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease at different rates than those of our liabilities, including our hedging instruments. See "Market Risk" below.

        The impact of changing interest rates on fair value can change significantly when interest rates change materially. Therefore, the volatility in the fair value of our assets could increase significantly in the event interest rates change materially. In addition, other factors impact the fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, changes in actual interest rates may have a material adverse effect on us.




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Market Risk

        Market value risk.    Our RMBSMBS are reflected at their fair value with unrealized gains and losses included in earnings. The fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the fair value of these securities would be expected to increase.

        The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments, including interest rate swaps, Agency Interest-Only Strips, Agency Inverse Interest-Only Strips, and net interest income at December 31, 2012,2013, assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager's expectations. The analysis presented utilizes our Manager's assumptions, models and estimates, which are based on our Manager's judgment and experience.

Change in Interest Rates		Percentage Change in Projected Net Interest Income			Percentage Change in Projected Portfolio Value
+1.00%			(2.99	)%		0.53	%
+0.50%			(0.27	)%		0.31	%
-0.50%			(9.03	)%		(0.87	)%
-1.00%			NA	(1)		NA	(1)

Change in Interest Rates		Percentage Change in Projected Net Interest Income			Percentage Change in Projected Portfolio Value
+1.00%			19.00	%		(1.09	)%
+0.50%			13.88	%		(0.40	)%
-0.50%			(26.54	)%		(0.28	)%
-1.00%			NA	(1)		NA	(1)

---

(1)

Not applicable, borrowing rate is below zero.



(2)

Includes linked real estate securities that are reported as a component of linked transactions in our balance sheets. Such securities may not be linked in future periods.




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        While the table above reflects the estimated immediate impact of interest rate increases and decreases on a static portfolio, we may rebalance our portfolio from time to time either to seek to take advantage of or reduce the impact of changes in interest rates. It is important to note that the impact of changing interest rates on market value and net interest income can change significantly when interest rates change beyond 100 basis points from current levels. Therefore, the volatility in the market value of our assets could increase significantly when interest rates change beyond amounts shown in the table above. In addition, other factors impact the market value of and net interest income from our interest rate-sensitive investments and derivative instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, interest income would likely differ from that shown above and such difference might be material and adverse to our stockholders.

        Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at December 31, 2012.2013. The analysis presented utilizes assumptions and estimates based on our Manager's judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change our interest rate risk profile.




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Prepayment Risk

        The value of our assets may be affected by prepayment rates on residential mortgage loans. We acquire RMBS and anticipate that the underlying residential mortgages loans will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis, in the case of Agency RMBS whole pools and certain other investment grade rated securities, and make a retrospective adjustment to historical amortization. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, the decrease in corresponding prepayments on the RMBS may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated and, in the case of Agency RMBS whole pools and certain other investment grade rated securities, will have to make a retrospective adjustment to historical amortization.

        Commercial mortgages frequently limit the ability of the borrower to prepay, thereby providing a certain level of prepayment protection. Common restrictions include yield maintenance and prepayment penalties, the proceeds of which are generally at least partially allocable to these securities, as well as defeasance.

Extension Risk

        Most residential mortgage loans do not prohibit the partial or full prepayment of principal outstanding. Accordingly, while the stated maturity of a residential mortgage loan may be 30 years, or in some cases even longer, historically the vast majority of residential mortgage loans are satisfied prior to their maturity date. In periods of rising interest rates, borrowers have less incentive to refinance their existing mortgages and mortgage financing may not be as readily available. This generally results in a slower rate of prepayments and a corresponding longer weighted average life for MBS. The increase, or extension, in weighted average life is commonly referred to as "Extension Risk" which can negatively impact our portfolio. To the extent we receive smaller pre-payments of principal; we will have less to capital to invest in new securities. This is extremely detrimental in periods of rising interest rates as we will be unable to invest in new higher coupon MBS and a larger portion of our portfolio will remain invested in lower coupon securities. Further, our borrowing costs are generally short-term and, even if hedged, are likely to increase in a rising interest rate environment, thereby reducing our net interest margin. Finally, to the extent we acquired MBS at a discount to par, a portion of the overall return on these securities is based on the recovery of this discount. Slower principal prepayments will result in a longer recovery period and a lower overall return on our investment.

Counterparty Risk

        The following discussion on counterparty risk describesreflects how these transactions work,are structured, rather than how they are presented for financial reporting purposes.

        When we engage in repurchase transactions, we generally sell securities to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders are obligated to resell the same securities back to us at the end of the term of the transaction. Because the cash we receive from the lender when we initially sell the securities to the lender is less than the value of those securities (this difference is the haircut), if the lender defaults on its obligation to resell the same securities back to us, we could incur a loss on the transaction up to the amount of the haircut (assuming there was no change in the value of the securities).




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        If a counterparty to ana bi-lateral interest rate swap cannot perform under the terms of the interest rate swap, we may not receive payments due under that agreement, and thus, we may lose any unrealized gain associated with the interest rate swap. We may also risk the loss of any collateral we have pledged to secure our obligations under interest rate swap if the counterparty becomes insolvent or files for bankruptcy. In the case of a cleared swap, if our clearing broker were to default, become insolvent or file for bankruptcy, we may also risk the loss of any collateral we have posted to the clearing broker unless we were able to transfer or "port" our positions and held collateral to another clearing broker. In addition, the interest rate swap would no longer mitigate the impact of changes in interest rates as intended. As of September 2013, most of our interest swaps are cleared through a central clearing house which reduces but does not eliminate the aforementioned risks. Also see "Liquidity Risk" below.




Table        Effective January 1, 2014, we have entered into master securities forward trading agreements, or MSFTAs, which would govern the trading of Contentsour TBA transactions. Pursuant to the terms of these MSFTAs, we and our counterparties would be required to post margin to the other when the mark to market exposure of the TBA transactions executed under the agreement exceed certain thresholds. On January 1, 2014, we entered into MSFTAs with two counterparties and we expect to continue to negotiate and enter into MSFTAs with additional TBA counterparties. The margin provisions of the MSFTA help to mitigate, but do not eliminate, counterparty risk associated with TBA transactions. If a counterparty to a TBA transaction cannot perform under the terms of the trade, we may not receive securities we have agreed to purchase or payment for securities we have agreed to sell, and thus, we may lose any unrealized gain associated with such transaction.

        Prior to entering into a trading agreement or transaction with any particular institution where we take on counterparty, our Manager does a thorough review of such potential counterparty. Such review, however, does not assure the creditworthiness of such counterparty nor that the financial wherewithal of the counterparty will not deteriorate in the future.

Funding Risk

        We have financed a substantial majority of our RMBSMBS with repurchase agreement financing. Over time, as market conditions change, in addition to these financings, we may use other forms of leverage. Weakness in the financial markets, the residential mortgage markets, the commercial mortgage markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing.

        If a counterparty to one of the TBAs that we may enter into defaults on its obligations, we may not receive payments or securities due under the TBA agreement, and thus, we may lose any unrealized gain associated with that TBA transaction.

Liquidity Risk

        Our liquidity risk is principally associated with the financing of long-maturity assets with short-term borrowings in the form of repurchase agreements. Although the interest rate adjustments of these assets and liabilities fall within the guidelines established by our operating policies, maturities are not required to be, nor are they, matched.

        Should the value of our assets pledged as collateral suddenly decrease, margin calls relating to our repurchase agreements could increase, causing an adverse change in our liquidity position. Our inability to post adequate collateral for a margin call by the counterparty could result in a condition of default under our repurchase agreements, thereby enabling the counterparty to liquidate the collateral pledged by us, which may have a material adverse consequence on our business and results of operations.




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        In an instance of severe volatility, or where the additional stress on liquidity resulting from volatility is sustained over an extended period of time, we could be required to sell securities, possibly even at a loss to generate sufficient liquidity to satisfy collateral and margin requirements which could have a material adverse effect on our financial position, results of operations and cash flows.

        Additionally, if one or more of our repurchase agreement counterparties chose not to provide on-going funding, our ability to finance would decline or exist at possibly less advantageous terms. Further, if we are unable to renew, replace or expand repurchase financing with other sources of financing on substantially similar terms, it may have ana material adverse effect on our business, andfinancial position, results of operations and cash flows, due to the long term nature of our investments and relatively short-term maturities of our repurchase agreements. As such, we cannot assure that we will always be able to roll over our repurchase agreements.

        The costs associated with our borrowings are generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase while the yields earned on our existing portfolio of leveraged fixed-rate RMBSMBS will remain static. This could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time, as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our assets. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affecthave a material adverse effect on our liquidity and results of operations.

        In addition, the assets that comprise our asset portfolio are not traded on a public exchange. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises, including in response to changes in economic and other conditions.




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        We enter into swaps to manage our interest rate risk. We are required to pledge cash or securities as collateral as part of a margin arrangement, calculated daily, in connection with the swaps. The amount of margin that we are required to post will vary by counterparty and generally reflects collateral posted with respect to swaps that are in an unrealized loss position to us and a percentage of the aggregate notional amount of swaps per counterparty. Margin calls could adversely affect our liquidity. Our inability to post adequate collateral for a margin call by the counterparty could result in a condition of default under our repurchase agreements, thereby enabling the counterparty to liquidateresulting in liquidation of the collateral pledged by us, which may have a material adverse consequence on our business, andfinancial position, results of operations.operations and cash flows. Conversely, if our swaps are in an unrealized gain position, our counterparties to bilateral swaps are required to post collateral with us, under the same terms that we post collateral with them.

Inflation

        Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily directly correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions will be determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our net taxable income on an annual basis, in accordance with the REIT regulations, in order to maintain our REIT qualification. In each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.




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Item 8.    Financial Statements and Supplementary Data.


Index to Financial Statements


Management's Annual Report on Internal Control over Financial Reporting
Report of Independent Registered Public Accounting Firm		80 94
Balance Sheets as of December 31, 20122013 and 20112012		81 95
Statement of Operations for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) to December 31, 2012		82 96
Statement of Changes in Stockholders' Equity for the period from January 1, 2012 toyears ended December 31, 2013 and December 31, 2012		83 97
Statement of Cash Flow for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) to December 31, 2012		84 98
Notes to Financial Statements		85 99

        All financial statement schedules have been omitted because the required information is not applicable or deemed not material, or the required information is presented in the financial statements and/or in the notes to financial statements.




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Report of Independent Registered Public Accounting Firm


To the Board of Directors and Shareholders
of Western Asset Mortgage Capital Corporation:

        In our opinion, the accompanying balance sheets and the related statements of operations, of changes in stockholders' equity, and of cash flows present fairly, in all material respects, the financial position of Western Asset Mortgage Capital Corporation at December 31, 20122013 and December 31, 2011,2012, and the results of its operations and its cash flows for the year ended December 31, 2013 and the period from May 15, 2012 (commencement of operations) through December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Los Angeles, California
/s/ PRICEWATERHOUSECOOPERS LLP
April 8, 2013Los Angeles, California
March 17, 2014




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Western Asset Mortgage Capital Corporation



Balance Sheets



(in thousands—except share and per share data)


		December 31, 2012			December 31, 2011				December 31, 2013			December 31, 2012
Assets:
Cash and cash equivalents		$	56,292		$	1			$	48,525		$	56,292
Residential mortgage-backed securities, at fair value ($5,043,824 pledged as collateral, at fair value)			5,212,581			—
Mortgage-backed securities, at fair value ($2,818,947 and $5,043,824 pledged as collateral, at fair value, respectively)										2,853,587			5,212,581
Linked transactions, net, at fair value										18,559			—
Investment related receivable										341			—
Accrued interest receivable			17,361							12,266			17,361
Due from counterparties			54,142			—				55,434			54,142
Derivative assets, at fair value			24,344			—				105,826			24,344
Other assets			244			—				339			244
​								​		​	​		​	​
Total Assets		$	5,364,964		$	1			$	3,094,877		$	5,364,964
​								​		​	​		​	​
​								​		​	​		​	​
Liabilities and Stockholders' Equity:
Liabilities:
Borrowings under repurchase agreements		$	4,794,730		$	—			$	2,579,067		$	4,794,730
Accrued interest payable			6,561			—				12,534			6,561
Due to counterparties										65,861			—
Derivative liability, at fair value			4,771			—				4,673			4,771
Cash overdraft payable			5,666							—			5,666
Accounts payable and accrued expenses			988			—				1,353			988
Underwriting and offering costs payable			75							8			75
Payable to related party			1,924			—				1,842			1,924
Dividend payable			27,041							19,445			27,041
​								​		​	​		​	​
Total Liabilities			4,841,756			—				2,684,783			4,841,756
​								​		​	​		​	​
Commitments and contingencies
Stockholders' Equity:
Common stock, $0.01 par value, 500,000,000 and 100,000 shares authorized, 24,143,944 and 100 shares issued and outstanding, respectively			241			—
Common stock, $0.01 par value, 500,000,000 shares authorized, 26,853,287 (including 2,548,784 shares declared as a stock dividend on December 19, 2013, issued on January 28, 2014) and 24,143,944 shares issued and outstanding, respectively										268			241
Preferred stock, $0.01 par value, 100,000,000 shares authorized and no shares outstanding			—			—				—			—
Additional paid-in capital			505,454			1				544,143			505,454
Retained earnings			17,513			—
Retained earnings (accumulated deficit)										(134,317	)		17,513
​								​		​	​		​	​
Total Stockholders' Equity			523,208			1				410,094			523,208
​								​		​	​		​	​
Total Liabilities and Stockholders' Equity		$	5,364,964		$	1			$	3,094,877		$	5,364,964
​								​		​	​		​	​
​								​		​	​		​	​

   

See notes to financial statements.




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Western Asset Mortgage Capital Corporation



Statement of Operations



(in thousands—except share and per share data)


		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Net Interest Income:
Interest income		$	53,318
Interest expense			8,094
Net Interest Income			45,224
Other Income (Loss):
Interest income on cash balances			11
Realized gain on sale of Residential mortgage-backed securities and other securities, net			20,754
Other loss on Residential mortgage-backed securities			(3,206	)
Unrealized gain on Residential mortgage-backed securities and other securities, net			13,930
Loss on derivative instruments, net			(13,106	)
Other Income (Loss), net			18,383
Operating Expenses:
General and administrative (includes $367 non-cash stock based compensation)			3,197
Management fee—related party			3,133
Total Operating Expenses			6,330
Net income available to Common Stock and participating securities		$	57,277
Earnings per Common Share—Basic		$	3.64
Earnings per Common Share—Diluted		$	3.63
Dividends Declared per Share of Common Stock		$	2.35

		For the year ended December 31, 2013			For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Net Interest Income:
Interest income		$	125,328		$	53,318
Interest expense			18,019			8,094
​	​	​	​	​	​	​	​
Net Interest Income			107,309			45,224
​	​	​	​	​	​	​	​
Other Income (Loss):
Interest income on cash balances and other income			91			11
Realized gain (loss) on sale of Mortgage-backed securities and other securities, net			(110,712	)		20,754
Other loss on Mortgage-backed securities			(11,858	)		(3,206	)
Unrealized gain (loss) on Mortgage-backed securities and other securities, net			(160,109	)		13,930
Gain on linked transactions, net			4,137			—
Gain (loss) on derivative instruments, net			157,547			(13,106	)
​	​	​	​	​	​	​	​
Other Income (Loss), net			(120,904	)		18,383
​	​	​	​	​	​	​	​
Operating Expenses:
General and administrative (includes $1,087 and $367 non-cash stock based compensation, respectively)			6,446			3,197
Management fee—related party			7,814			3,133
​	​	​	​	​	​	​	​
Total Operating Expenses			14,260			6,330
​	​	​	​	​	​	​	​
Net income (loss) available to Common Stock and participating securities		$	(27,855	)	$	57,277
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​
Net income (loss) per Common Share—Basic		$	(1.19	)	$	3.64
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​
Net income (loss) per Common Share—Diluted		$	(1.19	)	$	3.63
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​

   

See notes to financial statements.




Table of Contents


Western Asset Mortgage Capital Corporation



Statement of Changes in Stockholders' Equity



(in thousands—except shares and share data)


		Common Stock																Common Stock									Retained Earnings (Accumulated) Deficit
								Additional Paid-In Capital			Retained Earnings													Additional Paid- In Capital
		Shares			Par									Total				Shares			Par									Retained Earnings (Accumulated) Deficit
Balance at January 1, 2012 (commencement of operations)			100		$	—		$	1		$	—		$	1				100		$	—		$	1		$	—
Redemption of common stock			(100	)		—			(1	)		—			(1	)			(100	)		—			(1	)		—				)
Proceeds from public offering of common stock, net			21,800,000			218			461,312			—			461,530
Proceeds from public offerings of common stock, net																			21,800,000			218			461,312			—			461,530
Offering costs, public offerings of common stock			—			—			(1,759	)		—			(1,759	)			—			—			(1,759	)		—			(1,759	)
Proceeds from private placement of common stock			2,277,830			23			42,588			—			42,611				2,277,830			23			42,588			—			42,611
Warrants			—			—			2,946			—			2,946				—			—			2,946			—			2,946
Grants of restricted stock			66,114			—			—			—			—				66,114			—			—			—			—
Vesting of restricted stock			—			—			367			—			367				—			—			367			—			367
Net income			—			—			—			57,277			57,277				—			—			—			57,277			57,277
Dividends on common stock			—			—			—			(39,764	)		(39,764	)			—			—			—			(39,764	)		(39,764	)
​																	​		​	​		​	​		​	​		​	​		​	​
Balance at December 31, 2012			24,143,944		$	241		$	505,454		$	17,513		$	523,208				24,143,944		$	241		$	505,454		$	17,513		$	523,208
​																	​		​	​		​	​		​	​		​	​		​	​
Grants of restricted stock																			160,559			2			(2	)		—			—
Vesting of restricted stock																			—			—			1,024			—			1,024
Net loss																			—			—			—			(27,855	)		(27,855	)
Dividends on common stock																			2,548,784			25			37,667			(123,975	)		(86,283	)
​																	​		​	​		​	​		​	​		​	​		​	​
Balance at December 31, 2013																			26,853,287		$	268		$	544,143		$	(134,317	)	$	410,094
​																	​		​	​		​	​		​	​		​	​		​	​
​																	​		​	​		​	​		​	​		​	​		​	​

   

See notes to financial statements.




Table of Contents


Western Asset Mortgage Capital Corporation



Statement of Cash Flows



(in thousands)


		For the period from May 15, 2012 (commencement of operations) through December 31, 2012				For the year ended December 31, 2013			For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Cash flows from operating activities:
Net income		$	57,277
Adjustments to reconcile net income to net cash provided by operating activities:
Net income (loss)						$	(27,855	)	$	57,277
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Premium amortization and (discount accretion), net			16,725				21,053			16,725
Restricted stock amortization expense			367				1,087			367
Unrealized (gain) loss on Residential mortgage-backed securities and other securities, net			(13,930	)
Unrealized (gain) loss on Mortgage-backed securities and other securities, net							160,109			(13,930	)
Mark-to-market adjustments on linked transactions							(856	)		—
Mark-to-market adjustments on derivative instruments			(1,241	)			(84,788	)		(1,241	)
Other loss on Residential mortgage-backed securities			3,206
Realized (gain) loss on sale of Residential mortgage-backed securities and other securities, net			(20,754	)
Other loss on Mortgage-backed securities							11,858			3,206
Realized (gain) loss on sale of Mortgage-backed securities and other securities, net							110,712			(20,754	)
Realized loss on sale of Interest-Only Strips accounted for as derivatives, net							1,124			—
Realized loss on sale of TBAs, net							1,499			—
Realized gain on sale of swaptions, net							(23,671	)		—
Realized loss on expiration of option derivatives, net							925			—
Realized gain on linked transaction, net							(3,049	)		—	��
Changes in operating assets and liabilities:
Increase in accrued interest receivable			(17,361	)
Decrease (increase) in accrued interest receivable							5,095			(17,361	)
Increase in other assets			(244	)			(95	)		(244	)
Increase in accrued interest payable			6,561				5,973			6,561
Increase in accounts payable and accrued expenses			988				302			988
Increase in payable to related party			1,924
Increase (decrease) in payable to related party							(82	)		1,924
​					​		​	​		​	​
Net cash provided by operating activities			33,518				179,341			33,518
​					​		​	​		​	​
Cash flows from investing activities:
Purchase of Residential mortgage-backed securities and other securities			(7,798,967	)
Proceeds from sale of Residential mortgage-backed securities and other securities			2,490,326
Principal payments and basis recovered on Residential mortgage-backed securities and other securities			105,748
Payment of premium for interest rate swaptions			(13,267	)
Purchase of Mortgage-backed securities and other securities							(2,004,596	)		(7,798,967	)
Purchase of securities underlying linked transactions							(176,628	)		—
Proceeds from sale of Mortgage-backed securities and other securities							3,620,488			2,490,326
Proceeds from sale of securities underlying linked transactions							21,735			—
Principal payments and basis recovered on Mortgage-backed securities and other securities							305,433			105,748
Principal payments on securities underlying linked transactions							2,008			—
Payment of premium for option derivatives							(4,675	)		—
Premium received from option derivatives							3,750			—
Proceeds from gross settlement of TBAs							208,313			—
Net settlements of TBAs							(995	)		—
Proceeds from sale of interest rate swaptions							60,482			—
Premium for interest rate swaptions, net							(32,904	)		(13,267	)
Net cash used in investing activities			(5,216,160	)
​					​		​	​		​	​
Net cash provided by (used in) investing activities							2,002,411			(5,216,160	)
​					​		​	​		​	​
Cash flows from financing activities:
Proceeds from issuances of common stock			461,530				—			461,530
Proceeds from private placements of units and common stock (concurrent with initial public offering)			45,557				—			45,557
Payment of offering costs			(1,684	)			(67	)		(1,684	)
Redemption of common stock			(1	)			—			(1	)
Proceeds from repurchase agreement borrowings			14,511,707				29,948,206			14,511,707
Proceeds from repurchase agreement borrowings underlying linked transactions							165,089			—
Repayments of repurchase agreement borrowings			(9,716,977	)			(32,163,869	)		(9,716,977	)
Proceeds from cash overdraft			5,666
Repayments of repurchase agreement borrowings underlying linked transactions							(103,902	)		—
Proceeds from (Repayment of) cash overdraft							(5,666	)		5,666
Due from counterparties			(54,142	)			(1,292	)		(54,142	)
Due to counterparties							65,861			—
Dividends on common stock			(12,723	)			(93,879	)		(12,723	)
Net cash provided by financing activities			5,238,933
​					​		​	​		​	​
Net cash provided by (used in) financing activities							(2,189,519	)		5,238,933
Net increase in cash and cash equivalents			56,291
​					​		​	​		​	​
Net increase (decrease) in cash and cash equivalents							(7,767	)		56,291
Cash and cash equivalents beginning of period			1				56,292			1
​					​		​	​		​	​
Cash and cash equivalents end of period		$	56,292			$	48,525		$	56,292
​					​		​	​		​	​
​					​		​	​		​	​
Supplemental disclosure of operating cash flow information:
Interest paid		$	4,640			$	19,751		$	4,640
​					​		​	​		​	​
​					​		​	​		​	​
Supplemental disclosure of non-cash financing/investing activities:
Underwriting and offering costs payable		$	75			$	—		$	75
​					​		​	​		​	​
​					​		​	​		​	​
Principal payments of mortgage-backed securities, not settled						$	341		$	—
​					​		​	​		​	​
​					​		​	​		​	​
Mortgage-backed securities used to settle TBAs						$	208,817		$	—
​					​		​	​		​	​
​					​		​	​		​	​
Mortgage-backed securities recorded upon unlinking of linked transactions						$	(77,046	)	$	—
​					​		​	​		​	​
​					​		​	​		​	​
Stock dividends declared, not issued							37,671			—
​					​		​	​		​	​
​					​		​	​		​	​
Dividends and distributions declared, not paid		$	27,041			$	19,445		$	27,041
​					​		​	​		​	​
​					​		​	​		​	​

   

See notes to financial statements.




Table of Contents


Western Asset Mortgage Capital Corporation



Notes to Financial Statements



(in thousands—except share and per share data)


        The following defines certain of the commonly used terms in these Notes to Financial Statements: "Agency" or "Agencies" refer to a federally chartered corporation, such as the Federal National Mortgage Association ("Fannie Mae" or "FNMA") or the Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC"), or an agency of the U.S. Government, such as the Government National Mortgage Association ("Ginnie Mae" or "GNMA"); references to "RMBS""MBS" refer to refer to mortgage backed securities, including residential mortgage-backed securities "Agency RMBS"or "RMBS", commercial mortgage-backed securities or "CMBS", and "Interest-Only Strips" (as defined herin);"Agency MBS" refer to RMBS, CMBS and Interest-Only Strips issued or guaranteed by the Agencies while "Non-Agency RMBSMBS "refer to RMBS, CMBS and Interest-Only Strips that are not issued or guaranteed by the Agencies; references to "ARMs" refers to adjustable rate mortgages; and references to "Agency Derivatives" or "Agency Interest-Only"Interest-Only Strips" refer to interest-only("interest-only ("IO") and inverse interest-only ("IIO") securities issued as part of or collateralized with Agency RMBS.MBS.

Note 1—Organization

        Western Asset Mortgage Capital Corporation (is referred to throughout this report as the "Company") is a residential real estate finance company that primarily invests in residential mortgage assets in the United States. The Company is primarily focused on investing in, financing and managing Agency RMBS. Although the Company's core investment strategy is primarily focused on Agency RMBS, the Company has opportunistically supplemented its portfolio with Non-Agency RMBS, Agency and may,Non-Agency CMBS and, under certain market conditions, expects to increase its investment in Non-Agency RMBS and Agency and Non-Agency CMBS. In addition, the future,Company may opportunistically invest in commercial mortgage-backed securities ("CMBS") and asset-backed securities ("ABS"). as well.

        The Company was organized in the state of Delaware on June 3, 2009. The Company filed a Certificate of Dissolution in Delaware on May 5, 2010 and revoked such dissolutionis externally managed by filing a Certificate of Revocation of Dissolution on March 24, 2011. On March 24, 2011, Western Asset Management Company ("WAM", or the "Manager"), an investment advisor registered with the Securities and Exchange Commission ("SEC"), made a $1,000 initial capital contribution to the Company.. WAM is a wholly-owned subsidiary of Legg Mason, Inc. and is the external manager of the Company. The Company intends to electoperates and qualifyhas elected to be taxed as a real estate investment trust or "REIT" commencing with its taxable year ended December 31, 2012.

        At December 31, 2011 and through May 14, 2012, the Company complied with the reporting requirements for development stage enterprises and was subject to the risks associated with development stage enterprises. The Company completed its initial public offering and began its core operations on May 15, 2012. The Company incurred organizational, accounting and offering costs in connection with the Company's initial public offering (the "IPO") of its common stock and concurrent private placements. In accordance with the Management Agreement (as defined herein in Note 8)9) between the Company and the Manager, the Company reimbursed the Manager for $1.2 million of offering and other related organization costs, which were paid by the Manager, from the proceeds of the IPO and concurrent private placements. The Manager paid all costs in excess of $1.2 million. The Company ceased reporting as a development stage company on May 15, 2012.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies

Basis of Presentation

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("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 periods. Actual results could differ from those estimates.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        The Company currently operates as one business segment.

Cash and Cash Equivalents

        The Company considers all highly-liquid short term investments with original maturities of 90 days or less when purchased to be cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. The Company places its cash and cash equivalents with what it believes to be high credit quality institutions. At times such investments may be in excess of the Federal Deposit Insurance Corporation insurance limit.

Classification of mortgage-backed securities and valuations of financial instruments

Mortgage-backed and US Treasury securities—Fair value election

        The Company has elected the fair value option for all of its RMBSMBS and US Treasury securities at the date of purchase, which permits the Company to measure these securities at fair value with the change in fair value included as a component of earnings. In the Manager's view, this election more appropriately reflects the results of the Company's operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of economic hedging instruments.

Balance Sheet Presentation

        The Company's mortgage-backed securities purchases and sales are recorded on the trade date, which results in an investment related payable (receivable) for RMBSMBS purchased (sold) for which settlement has not taken place as of the balance sheet date. The Company's RMBSMBS are pledged as collateral against borrowings under repurchase agreementsagreements. Other than MBS which are accounted for as linked transactions, described below, the Company's MBS are included in residential mortgage-backedMortgage-backed securities at fair value and Investment related receivables on the balance sheet,Balance Sheet, with the fair value of such securitiesMBS pledged disclosed parenthetically.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Valuation of financial instruments

        The Company discloses the fair value of its financial instruments according to a fair value hierarchy (Levels I, II, and III, as defined below). In accordance with GAAP, the Company is required to provide enhanced disclosures regarding instruments in the Level III category (which require significant management judgment), including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities. GAAP establishes a framework for measuring fair value and expands financial statement disclosure requirements for fair value measurements. GAAP further specifies a hierarchy of valuation techniques, which is based on whether the inputs into the valuation technique are observable or unobservable. The hierarchy is as follows:

        Level I—Quoted prices in active markets for identical assets or liabilities.

        Level II—Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        Level III—Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable, (forfor example, when there is little or no market activity for an investment at the end of the period),period, unobservable inputs may be used.

        The level in the fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Transfers between levels are determined by the Company at the end of the reporting period.

        When available, the Company uses quoted market prices to determine the fair value of an asset or liability. If quoted market prices are not available, the Company consults with independent pricing services or obtains third party broker quotes. If independent pricing service, or third party broker quotes are not available, the Company determines the fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates.rates and when applicable, estimates of prepayment and credit losses.

        Valuation techniques for RMBSMBS may be based upon models that consider the estimated cash flows of the security. TheWhen applicable, the primary inputs to the model include yields for to-be-announced, alsoAgency To-Be-Announced securities (also known as TBAs,"TBAs"), Agency RMBS,MBS, the U.S. Treasury market and floating rate indices such as the London interbank offered rate or LIBOR, the Constant Maturity Treasury rate and the prime rate as a benchmark yield. TheIn addition, the model incorporatesmay incorporate the current weighted average maturity and additional pool level information such as prepayment speeds, default frequencies and default severities, if applicable. To the extent, thesuch inputs are observable and timely, the valuesthese MBS are categorized inas Level II of the fair value hierarchy; otherwise, unless alternative pricing information as described above is available, they would beare categorized as Level III.

        While linked transactions, described below, are treated as derivatives for GAAP, the securities underlying the Company's linked transactions are valued using similar techniques to those used for the Company's securities portfolio. The value of the underlying security is then netted against the carrying amount (which approximates fair value) of the repurchase agreement at the valuation date. Additionally, TBA instruments are similar in substance to the Company's Agency RMBS portfolio, and the Company therefore estimates fair value based on similar methods.

        The Company determines the fair value of derivative financial instruments and obtainsby obtaining quotes from a third party pricing service, whose pricing is subject to facilitatereview by the processManager's pricing committee. In valuing its interest rate derivatives, such as swaps and swaptions, the Company considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement, from the perspective of both the Company and its counterparties. All of the Company's interest rate swaps are either cleared through a central clearing house and subject to the clearing house margin requirements or subject to bilateral collateral arrangements. The Company also has netting arrangements in place with all derivative counterparties, however the Company has elected to report the interest rate swaps on a gross basis. No credit valuation adjustment was made in determining thesethe fair values.value of interest rate derivatives.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        In May 2011, the Financial Accounting Standards Board or FASB issued amendments, which were adopted by the Company, to achieve common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. New disclosures, with a particular focus on Level III measurement are required. All transfers between Level I and Level II are required to be disclosed. There were no transfers between hierarchy levels during operations for the period from May 15, 2012 (commencement of operations) through December 31, 2012. Information about when the current use of a non-financial asset measured at fair value differs from its highest and best use is to be disclosed. The Company does not hold any Level III assets and therefore, this update has no significant effect on the Company's financial statements.

        Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company is forced to sell assets in a short period to meet liquidity needs, the prices it receives can be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that the Company will not be required to sell securities in an unrealized loss position prior to an expectedbefore recovery in value (if any),of its amortized cost basis, the amount of such expected required sales, and the projected identification of which securities will be sold is also subject to significant judgment, particularly in times of market illiquidity.

        Any changes to the valuation methodology will be reviewed by the Company and its Manager to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, the Company will continue to refine its valuation methodologies. The Company utilizes and follows the pricing methodology employed by its Manager, including its review and challenge process. The methods used by the Company may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company anticipates that its valuation methods will be appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments can result in a different estimate of fair value at the reporting date. The Company uses inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.

        All valuations received from independent pricing services are non-binding. The Company primarily utilizes an independent third party pricing service as the primary source for valuing the Company's assets.

        The Company generally receives one independent pricing service price for each investment in the Company's portfolio. The Manager has established a process to review and validate the pricing received from the independent pricing service and has a process for challenging prices received from the independent pricing service when necessary. The Company utilizes our Manager's policies in this regard. The Company's and the Manager's review of the independent third party pricing data may consist of a review of the daily change in the prices provided by the independent pricing vendor which exceed established tolerances or comparisons to executed transaction prices. The Manager's pricing group, which functions independently from its portfolio management personnel, corroborates the price differences or changes in price by comparing the vendor price to alternate sources including other independent pricing services or broker quotations. If the price change or difference cannot be corroborated, the Manager's pricing group consults with the portfolio management team for market color in reviewing such pricing data as warranted. To the extent that the Manager has information, typically in the form of broker quotations that would indicate that a price received from the independent pricing service is outside of a tolerance range, our Manager generally challenges the independent pricing service price.

        To ensure proper fair value hierarchy, The Company and the Manager review the methodology used by the third party pricing service to understand whether observable market data is being utilized in the vendor's pricing methodology. Generally, this review is conducted annually, however ad-hoc reviews of the pricing methodology and the data does occur. The review of the assumptive data received from the vendor includes comparing key inputs. In addition, as part of the Company's regular review of pricing, the Manager's pricing group may have informal discussions with the independent pricing vendor regarding their evaluation methodology or the market data utilized in their determination. The conclusion that a price should be overridden in accordance with the Manager's pricing methodology may impact the fair value hierarchy of the security for which such price has been adjusted.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Interest income recognition and Impairment

Agency MBS and Non-Agency MBS, excluding Interest-Only Strips, rated AA and higher at the time of purchase

        Interest income on mortgage-backed securities is accrued based on the respective outstanding principal balances and corresponding contractual terms. Premiums and discounts associated with Agency RMBSMBS and Non-Agency RMBSMBS, excluding Interest-Only Strips, rated AA and higher at the time of purchase, are amortized into interest income over the estimated life of such securities using the effective yield method. Adjustments to premium and discount amortization are made for actual prepayment activity. The Company estimates prepayments at least quarterly for its securities and as a result, if prepayments increase (or are expected to increase), the Company will accelerate the rate of amortization on premiums or discounts and make a retrospective adjustment to historical amortization. Alternatively, if prepayments decrease (or are expected to decrease) the Company will reduce the rate of amortization on the premiums or discounts and make a retrospective adjustment to historical amortization.

        The Company assesses its Agency MBS and its Non-Agency MBS, excluding Interest-Only Strips, rated AA and higher at the time of purchase for other-than-temporary impairment on at least a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either "temporary" or "other-than-temporary." In deciding on whether or not a security is other-than-temporarily impaired, the Company considers several factors, including the nature of the investment, communications (if any) from the trustees of securitizations regarding the credit quality of the security, the severity and duration of the impairment, the cause of the impairment, and the Company's intent not to sell the security and whether it is more likely than not that Company will not be required to sell the security until recovery of its amortized cost basis. An other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the security is less than its carrying amount. In determining whether an adverse change in cash flows occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those a "market participant" would use and are discounted at a rate equal to the current yield used to accrete interest income. These adjustments are reflected in the Company's Statement of Operations as Other loss on Mortgage-backed securities.

        The determination as to whether an other-than-temporary impairment exists is subject to management estimates based on consideration of both factual information available at the time of assessment as well as the Company's estimates of the future performance and projected amount and timing of cash flows expected to be collected on the security. As a result, the timing and amount of an other-than-temporary impairment constitutes an accounting estimate that may change materially over time.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        Interest income on Non-Agency RMBSMBS that are purchased at a discount to par value and/or are rated below AA at the time of purchase isand Interest-Only Strips that are not classified as derivatives

        Interest income on Non-Agency MBS that are rated below AA at the time of purchase and Interest-Only Strips that are not classified as derivatives are recognized based on the effective yield method. Similar treatment is afforded to the Company's portfolio of Agency Interest-Only Strips that are not classified as derivatives. The effective yield on these securities is based on the projected cash flows from each security, which is estimated based on the Company's observation of the then current information and events and will include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses (if applicable), and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of scheduled principal, and prepayments of principal. Therefore, actual maturities of the securities will generally be shorter than stated contractual maturities.

        Based on the projected cash flow of the Non-Agency RMBSMBS purchased at a discount to par value, the Company may designate a portion of such purchase discount as credit protection against future credit losses and, therefore, not accrete such amount into interest income. The amount designated as credit discount may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit discount is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income prospectively

        In addition, an other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the security is less than its carrying amount. In determining whether an adverse change in cash flows occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those a "market participant" would use and are discounted at a rate equal to the current yield used to accrete interest income. These adjustments are reflected in the Company's Statement of Operations as Other loss on Residential mortgage-backedMortgage-backed securities.

        The determination ofas to whether an other-than-temporary impairment exists is subject to management estimates based on consideration of both factual information available at the time of assessment as well as the Company's estimates of the future performance and projected amount and timing of cash flows expected to be collected on the security. As a result, the timing and amount of an other-than-temporary impairment constitutes an accounting estimate that may change materially over time.

        Certain of the Company's MBS that are in an unrealized loss position at December 31, 2013 are not considered other-than-temporarily impaired because the Company has no intent to sell these investments, it is more likely than not that the Company will not be required to sell the investment before recovery of its amortized cost basis and the Company is not required to sell the security for regulatory or other reasons.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Sales of securities

        Sales of securities are driven by the Company's portfolio management process. The Company seeks to mitigate risks including those associated with prepayments and will opportunistically rotate the portfolio into securities the Company's Manager believe have more favorable attributes. Strategies may also be employed to manage net capital gains, which need to be distributed for tax purposes. Realized gains or losses on sales of securities, including Agency Interest-Only Strips not characterized as derivatives, are included in the net Realized gain (loss) on sale of Mortgage-backed securities and other securities, net line item on the Statement of Operations, and are recorded at the time of disposition. Realized gains or losses on sales of securities which are part of a linked transaction are included in Gain (loss) on linked transactions, net while realized gains losses on Interest-Only Strips which are characterized as derivatives are included in Gain (loss) on derivative instruments, net line item in the Statement of Operations. The cost of positions sold is calculated using the specific identification method.

        Securities in an unrealized loss position at the end of each reporting period are evaluated by the Company's Manager to determine whether the Company has the intent to sell such securities. To the extent the Company has no intent to sell such investments and it is more likely than not that the Company will not be required to sell the investment before recovery of its amortized cost basis, such unrealized loss is included in Unrealized gain (loss) on Mortgage-backed securities and other securities, net in the Statement of Operations. Otherwise, when the Company has determined its intent to sell such securities, the unrealized loss is characterized as a realized loss and included in Other loss on Mortgage-backed securities on the Statement of Operations.

Due from counterparties/Due to counterparties

        Due from counterparties represents cash posted with its counterparties as collateral for the Company's interest rate swaps interest rate swaptions and repurchase agreements. Due to counterparties represents cash posted with the Company by its counterparties as collateral under the Company's interest rate swaps, interest rate swaptions and repurchase agreements. Due from counterparties andIn addition, as provided below, Due to counterparties may include non-cash collateral in which the Company has the obligation to return the collateral upon the Company either selling or pledging the non-cash collateral. To the extent the Company receives collateral other than cash from its counterparties such assets are carried at cost, which approximates fair value.not included in the Company's Balance Sheet. Notwithstanding the foregoing, if the Company either rehypothecates such assets or pledges the assets as collateral pursuant to a repurchase agreement, the cash received and the corresponding liability is reflected on the Balance Sheet.

Derivatives and hedging activities

        Subject to maintaining its qualification as a REIT for U.S. federal income tax purposes, the Company utilizes derivative financial instruments, including interest rate swaps, swaptions, U.S. treasuries, to-be-announced securities ("TBAs")TBAs and Agency and Non-Agency Interest-Only Strips to hedge the interest rate risk associated with its portfolio and related borrowings. Derivatives are used for hedging purposes rather than speculation. The Company determines the fair value of its derivative positions and obtains quotations from a third party to facilitate the process of determining these fair values. If the Company's hedging activities do not achieve the desired results, reported earnings may be adversely affected.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        GAAP requires an entity to recognize all derivatives as either assets or liabilities and to measure those instruments at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives are classified as either hedges of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge) or hedges of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). Fair value adjustments are recorded in earnings immediately, if the Company does not elect hedge accounting for a derivative instrument.

        The Company elected not to apply hedge accounting for its derivative instruments and records the change in fair value and net interest rate swap payments (including accrued amounts) related to interest rate swaps in LossGain (loss) on derivative instruments, net in its statementStatement of operations.Operations.

        The Company also invests in Agency and Non-Agency Interest-Only Strips, Agency and Non-Agency Inverse Interest-Only Strips, swaptions and TBAs. The Company evaluates the terms and conditions of its holdings of Agency and Non-Agency Interest-Only Strips, Agency and Non-Agency Inverse Interest-Only Strips, swaptions and TBAs to determine if these instruments have the characteristics of an investment or should be considered a derivative under GAAP. Accordingly, Agency and Non-Agency Interest-Only Strips, Agency and Non-Agency Inverse Interest-Only Strips, swaptions and TBAs having the characteristics of derivatives are accounted for at fair value with such changes recognized in LossGain (loss) on derivative instruments, net in its statementStatement of operations,Operations, along with any interest earned (including accrued amounts). The carrying value of these Agency and Non-Agency Interest-Only Strips, Agency and Non-Agency Inverse Interest-Only Strips, swaptions and TBAs is included in Residential mortgage-backedMortgage-backed securities on the balance sheet.Balance Sheet.

        The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. An embedded derivative is separated from the host contact and accounted for separately when all of the guidance criteria are met. Hybrid instruments that are remeasured at fair value through earnings, including the fair value option are not bifurcated. Derivative instruments, including derivative instruments accounted for as liabilities, are recorded at fair value and are re-valued at each reporting date, with changes in the fair value together with interest earned (including accrued amounts) reported in the Gain (loss) on derivatives, net in the Statements of Operations. See "Warrants" below.

Repurchase agreements

        Mortgage-backed securities sold under repurchase agreements are treated as collateralized financing transactions, unless they meet sales treatment. Securities financed through a repurchase agreement remain on the Company's Balance Sheet as an asset and cash received from the lender is recorded in the Company's Balance Sheet as a liability, unless they are accounted for as linked transactions, described below. Interest paid in accordance with repurchase agreements is recorded as interest expense, unless they are accounted for as linked transactions, described below. The Company reflects all proceeds from repurchase agreement borrowings and repayment of repurchase agreement borrowings which are not linked transactions, including transactions pertaining to collateral received with respect to certain swap transactions, on a gross basis on the Statement of Cash Flows.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        The Company evaluates all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. Derivative instruments are recorded at fair value and are re-valued at each reporting date, with changes in the fair value together with interest earned (including accrued amounts) reported in loss on derivatives in the statements of operations.

Repurchase agreementsLinked transactions

        Mortgage-backed securities sold under repurchase agreements are treated as collateralized financing transactions, unless they meet sales treatment. Securities financed through a repurchase agreement remain on the Company's balance sheet as an asset and cash received from the lender is recorded in the Company's balance sheet as a liability. Interest paid in accordance with repurchase agreements is recorded as interest expense.

        In instances where the Company acquires securities through repurchase agreements with the same counterparty from whichwhom the securities were purchased, the Company will account forevaluates such transactions in accordance with GAAP. This guidance requires the purchase commitmentinitial transfer of a financial asset and repurchase agreementfinancing that are entered into contemporaneously with, or in contemplation of, one another to be considered linked unless all of the criteria found in the guidance are met at the inception of the transaction. If the transaction meets all of the conditions, the initial transfer shall be accounted for separately from the repurchase financing, and the Company will record the securities and the related financing on a gross basis on its Balance Sheet with the corresponding interest income and interest expense in the Statements of Operations. If the transaction is determined to be linked, the Company will record the initial transfer and repurchase financing on a net basis and record a forward commitment to purchase securities as a derivative instrument ifwith changes in market value being recorded on the transaction does not comply with the criteria for gross presentation.Statement of Operations. Such forward commitments will beare recorded at fair value with subsequent changes in fair value recognized in income. Additionally, the Company will record the cash portion of its investment in securities as a mortgage-related receivable from the counterpartyGain (loss) on linked transactions, net on its balance sheet. IfStatement of Operations. The Company refers to these transactions as Linked Transactions. When or if a transaction is no longer considered to be linked, the transaction complies with the criteria for gross presentation, the Companyreal estate security and related repurchase financing will record the assets and the related financingbe reported on a gross basis. The unlinking of a transaction causes a realized event in which the fair value of the real estate security as of the date of unlinking will become the cost basis in its balance sheetof the real estate security. The difference between the fair value on the unlinking date and the corresponding interest income and interest expense in its statement of operations. Allexisting cost basis of the Company'ssecurity will be the realized gain or loss. Recognition of effective yield for such security will be calculated prospectively using the new cost basis. For linked transactions, the Company reflects purchases and sales of securities within the investing section of the Statement of Cash Flows. Proceeds from repurchase agreements borrowings and repayments of repurchase agreement borrowings are treated as collateralizedreflected in the financing transactions.section of the Statement of Cash Flows.

Share-based compensation

        The Company accounts for share-based compensation to its independent directors, to its employees, to its Manager and to employees of its Manager and its affiliates using the fair value based methodology prescribed by GAAP. Compensation cost related to restricted common stock issued to the Company's independent directors including any such restricted stock which is subject to a deferred compensation program, and employees of the Company is measured at its fair value at the grant date, and amortized into expense over the service period on a straight-line basis. Compensation cost related to restricted common stock issued to the Manager and to employees of the Manager and its affiliates is initially measured at fair value at the grant date, and amortized into expense over the vesting period on a straight-line basis and re-measured on subsequent dates to the extent the awards are unvested.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Warrants

        The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. Financial instruments without these features are recorded as a component of equity.        For the Company's warrants, the Company uses a variation of the adjusted Black-Scholes option valuation model to record the financial instruments at their relative fair values at issuance. The warrants issued with the Company's common stock in the private placement to certain accredited institutional investors on May 15, 2012, have beenwere evaluated by the Company and have beenwere recorded at their relative fair value as a component of equity.equity at the date of issuance. See "Derivatives and hedging activities" above.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Income taxes

        The Company intends to electoperates and qualifyhas elected to be taxed as a REIT commencing with its taxable year ended December 31, 2012. Accordingly, the Company will generally not be subject to corporate U.S. federal or state income tax to the extent that the Company makes qualifying distributions to stockholders, and provided that the Company satisfies, on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, the Company will be subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the Company lost its REIT qualification. Accordingly, the failure to qualify as a REIT could have a material adverse impact on the Company's results of operations and amounts available for distribution to stockholders.

        The dividends paid deduction for qualifying dividends paid to stockholders is computed using the Company's taxable income as opposed to net income reported on the financial statements. Taxable income, generally, will differ from net income reported on the financial statements because the determination of taxable income is based on tax provisions and not GAAP.

        The Company may create and elect to treat certain subsidiaries as Taxable REIT Subsidiaries ("TRS"). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A TRS is subject to U.S. federal, state and local corporate income taxes, and its value may not exceed 25% of the value of the Company. While a TRS will generate net income, a TRS can declare dividends to the Company, which will be included in the Company's taxable income and necessitate a distribution to its stockholders. Conversely, if the Company retains earnings at the TRS level, no distribution is required and it can increase book equity of the consolidated entity. As of December 31, 2012,2013, the Company did not have a TRS, or any other subsidiary.

        The Company evaluates uncertain tax positions, if any, and classifies interest and penalties, if any, related to unrecognized tax benefits as a component of the provision for income taxes.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Offering costs

        Offering costs borne by the Company in connection with the IPO and concurrent private placements completed on May 15, 2012 as well as its follow-on public stock offering completed on October 3, 2012 are reflected as a reduction of additional paid-in-capital.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

Earnings per share

        GAAP requires use of the two-class method of computing earnings per share for all periods presented for each class of common stock and participating securities as if all earnings for the period had been distributed. Under the two-class method, during periods of net income, the net income is first reduced for dividends declared on all classes of securities to arrive at undistributed earnings. During periods of net losses, the net loss is reduced for dividends declared on participating securities only if the security has the right to participate in the earnings of the entity and an objectively determinable contractual obligation to share in net losses of the entity. The Company's participating securities are not allocated a share of the net loss as the participating securities do not have a contractual obligation to share in the net losses of the Company.

        The remaining earnings are allocated to common stockholders and participating securities, to the extent that each security shares in earnings, as if all of the earnings for the period had been distributed. Each total is then divided by the applicable number of shares to arrive at basic earnings per share. For the diluted earnings, the denominator includes all outstanding common shares and all potential common shares assumed issued if they are dilutive. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of these potential common shares.

Comprehensive Income (Loss)

        The Company has none of the components of comprehensive income (loss) and therefore comprehensive income (loss) is not presented.

Accounting standards applicable to emerging growth companies

        The JOBS Act contains provisions that relax certain requirements for "emerging growth companies", which includes the Company. For as long as the Company is an emerging growth company, which may be up to five full fiscal years, unlike other public companies, the Company will not be required to: (i) comply with any new or revised financial accounting standards applicable to public companies until such standards are also applicable to private companies under Section 102(b)(1) of the JOBS Act; (ii) provide an auditor's attestation report on management's assessment of the effectiveness of the Company's system of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act; (iii) comply with any new requirements adopted by the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer; or (iv) comply with any new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)

        As noted above, under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies. The Company intends to take advantage of such extended transition period. Since the Company will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, its financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If the Company were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act.

Recent accounting pronouncements

Accounting Standards Adopted in 2012

        In April 2011, the Financial Accounting Standards Board ("FASB") amended existing guidance for agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity. The amendments remove from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and the collateral maintenance implementation guidance related to that criterion. The guidance became effective for the first interim or annual period beginning on or after December 15, 2011 on a prospective basis. The adoption of this guidance did not have a material impact on the Company's financial statements.

        In May 2011, the Financial Accounting Standards Board, or FASB, issued guidance that clarifies its intent regarding the application of existing fair value measurement requirements including: (i) prohibiting the inclusion of block discounts in all fair value measurements, not just Level I measurements; (ii) adding guidance on when to include other premiums and discounts in fair value measurements; (iii) clarifying that the concepts of "highest and best use" and "valuation premise" apply only when measuring the fair value of non-financial assets; and (iv) adding an exception that allows the measurement of a group of financial assets and liabilities with offsetting risks (a portfolio of derivative contracts) at their net exposure to a particular risk if certain criteria are met. For non-public entities, this guidance is effective for fiscal years beginning after December 15, 2011. The adoption of this guidance did not have a material impact on the Company's financial statements.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 2—Summary of Significant Accounting Policies (Continued)




Recent accounting pronouncements

Accounting Standards to be Adopted by us in Future Periods2013

        In December 2011, the FASB issued guidance requiring additional disclosure information about offsetting and related arrangements. Further in December 2012, the FASB proposed an update intended to address implementation of the December 2011 guidance. In January 2013, the FASB issued guidance to limit the scope of the new balance sheet and offsetting disclosure requirements of prior guidance related to certain derivatives (including bifurcated embedded derivatives,)derivatives), repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions. Entities will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet as well as instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements, and reverse sale and repurchase agreements, and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards. The guidance is effective for periods beginning on or after January 1, 2013 and interim periods within those annual periods. While this guidance maydid result in certain additional disclosures, it isdid not expected to have a material impact on the Company's financial statements.

Note 3—Fair Value of Financial Instruments

Fair Value Accounting Elections

        The CompanyCompany's MBS are designated as available-for-sale and has elected the fair value option for all of its RMBSMBS, and as a result, all changes in the fair value of such securities are reflected in the results of operations.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 3—Fair Value of Financial Instruments (Continued)

Financial Instruments carried at Fair Value

        The following tables present the Company's financial instruments carried at fair value as of December 31, 2013 and December 31, 2012, based upon the valuation hierarchy (dollars in thousands):

															December 31, 2013
		Fair value													Fair Value
		Level I			Level II			Level III			Total				Level I			Level II			Level III			Total
Assets
Agency RMBS		$	—		$	5,118,121		$	—		$	5,118,121			$	—		$	2,360,073		$	—		$	2,360,073
Agency and Non-Agency Interest-Only Strips accounted for as derivatives, included in MBS																—			109,235			—			109,235
Non-Agency RMBS						19,073						19,073				—			352,056			6,152			358,208
Agency Interest-Only Strips accounted for as derivatives, included in RMBS			—			75,387			—			75,387
Agency and Non-Agency CMBS																—			16,542			9,529			26,071
​														​		​	​		​	​		​	​		​	​
Subtotal						5,212,581						5,212,581				—			2,837,906			15,681			2,853,587
Derivative assets			—			24,344			—			24,344				—			105,826			—			105,826
Non-Agency linked transactions																—			18,559			—			18,559
​														​		​	​		​	​		​	​		​	​
Total		$	—		$	5,236,925		$	—		$	5,236,925			$	—		$	2,962,291		$	15,681		$	2,977,972
​														​		​	​		​	​		​	​		​	​
Liabilities
Derivative liabilities		$	—		$	4,771		$	—		$	4,771			$	—		$	4,673		$	—		$	4,673
​														​		​	​		​	​		​	​		​	​
Total		$	—		$	4,771		$	—		$	4,771			$	—		$	4,673		$	—		$	4,673
​														​		​	​		​	​		​	​		​	​




		December 31, 2012
		Fair value
		Level I			Level II			Level III			Total
Assets
Agency RMBS		$	—		$	5,118,121		$	—		$	5,118,121
Non-Agency RMBS						19,073						19,073
Agency Interest-Only Strips accounted for as derivatives, included in RMBS			—			75,387			—			75,387
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Subtotal						5,212,581						5,212,581
Derivative assets			—			24,344			—			24,344
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	—		$	5,236,925		$	—		$	5,236,925
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Liabilities
Derivative liabilities		$	—		$	4,771		$	—		$	4,771
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	—		$	4,771		$	—		$	4,771
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 3—Fair Value of Financial Instruments (Continued)

        The following table presents additional information about the Company's MBS which is measured at fair value on a recurring basis for which the Company has utilized Level III inputs to determine fair value:

$ in thousands		Year ended December 31, 2013			Period from May 15, 2012 (commencement of operations) through December 31, 2012
Beginning balance			—			—
Transfers into Level III from Level II			9,529			—
Transfers out Level III into Level II			—			—
Purchases			6,262			—
Sales and settlements			—			—
Principal repayments			—			—
Total net gains / (losses) included in net income			—			—
Realized gains/(losses), net			—			—
Other loss on Mortgage-backed securities			(14	)		—
Unrealized gains/(losses), net			(101	)		—
Premium and discount amortization, net			5			—
​	​	​	​	​	​	​	​
Ending balance			15,681			—
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​

        There was one transfer between hierarchy levels during operations for the year ended December 31, 2013. The asset which was transferred from Level II to Level III as of December 31, 2013, consisted of a security for which there were insufficient observable inputs. Valuation for this asset was based on information received from a third party pricing service which utilized significant unobservable inputs. Accordingly, the Company determined that this asset should be classified as Level III asset.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 3—Fair Value of Financial Instruments (Continued)

        The Company usesprimarily utilizes an independent third party pricing services as the primary source for valuing the Company's assets. All valuations received from independent pricing services are non-binding. The Company generally receives one independent pricing service price for each investment in its portfolio. The Manager has established a process to pricereview and validate the pricing received from the independent pricing service at the end of the reporting period and has a process for challenging prices received from the independent pricing service when necessary. The Company utilizes its RMBSManager's policies in this regard. The Company's and derivative instruments. Where available, prices from multiplethe Manager's review of the independent third party pricing data may consist of a review of the daily change in the prices provided by the independent pricing vendor which exceed established tolerances or comparisons to executed transaction prices. The Manager's pricing group, which functions independently from its portfolio management personnel, corroborates the price differences or changes in price by comparing the vendor price to alternate sources including other independent pricing services are compared against each other. Where available,or broker quotations. If the price change or difference cannot be corroborated, the Manager's pricing group consults with the portfolio management team for market color in reviewing such pricing data as warranted. To the extent that the Manager has information, typically in the form of broker quotations that would indicate that a price received from the independent pricing service is outside of a tolerance range, the Manager generally challenges the independent pricing service price. To ensure proper fair value hierarchy, the Company and the Manager review the methodology used by the third party pricing service to understand whether observable market data is compared against bid/offerbeing utilized in the vendor's pricing from broker-dealers. Finally, trade execution prices are compared tomethodology. Generally, this review is conducted annually, however ad-hoc reviews of the most recently available price from third party pricing services.methodology and the data does occur. In addition, as part of the Company's regular review of pricing, the Manager's pricing group may have informal discussions with the independent pricing vendor regarding their evaluation methodology or the market data utilized in their determination.

Other Fair Value Disclosures

        Cash and cash equivalents as well as Due from counterparties and Due to counterparties on the Company's balance sheetBalance Sheets are reflected at cost which approximates fair value.

        The fair value of the repurchase agreements is a Level II fair value measurement, based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best estimatedestimate current market interest rates that would be offered for loans with similar characteristics and credit quality. The use of different market assumptions or estimation methodologies can have a material effect on the fair value amounts. At December 31, 2012,2013, the Company's borrowings under repurchase agreements had a fair value of approximately $4.8$2.6 billion and a carrying value of approximately $4.8$2.6 billion.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 4—Residential Mortgage-Backed Securities

        The following table presents certain information about the Company's investment portfolio at December 31, 2013 and December 31, 2012 (dollars in thousands):

		Principal Balance			Unamortized Premium (Discount), net			Non-Accretable Discount			Amortized Cost			Unrealized Gain (Loss), net			Estimated Fair Value			Net Weighted Average Coupon(1)
Agency RMBS:
20-Year Mortgage		$	299,251		$	20,460		$			$	319,711		$	(827	)	$	318,884			3.2	%
30-Year Mortgage			4,180,104			352,378						4,532,482			17,489			4,549,971			3.7	%
CMO—Fixed rate			66,000			9,776						75,776			(1,546	)		74,230			6.5	%
Agency Interest Only-Strips			N/A			N/A						176,093			(1,057	)		175,036			4.5	%(2)
Agency Interest-Only Strips, accounted for as derivatives(3)			N/A			N/A						N/A			N/A			75,387			4.9	%(2)
Non-Agency RMBS			37,372			(5,511	)		(12,659	)		19,202			(129	)		19,073			0.5	%
Total		$	4,582,727		$	377,103		$	(12,659	)	$	5,123,264		$	13,930		$	5,212,581			3.9	%

---

(1)

Net weighted average coupon as of December 31, 2012 is presented, net of servicing and other fees.

(2)

Agency Interest-Only Strips and Agency Interest-Only Strips,. Real estate securities that are accounted for as derivatives have no principal balances and earn contractual interest based on a notional balance. The notional balance is used solely to determine interest distributions on interest-only class of securities.

(3)

Interest on these securities is reported as a component of Loss on derivative instruments.

        Weighted average expected remaining term tolinked transactions are not reflected in the expected maturity of the investment portfolio is 8.8 years.tables set forth in this note. See Note 7 for further details.

		December 31, 2013
		Principal Balance			Unamortized Premium (Discount), net			Discount Designated as Credit Reserve and OTTI			Amortized Cost			Unrealized Gain (Loss), net			Estimated Fair Value			Net Weighted Average Coupon(1)
Agency RMBS:
20-Year Mortgage		$	504,023		$	28,498		$	—		$	532,521		$	(29,595	)	$	502,926			3.2	%
30-Year Mortgage			1,677,863			144,356			—			1,822,219			(127,981	)		1,694,238			3.8	%
Agency RMBS Interest-Only Strips			N/A			N/A			N/A			158,825			4,084			162,909			4.4	%(2)
Agency and Non-Agency Interest-Only Strips, accounted for as derivatives(3)			N/A			N/A			N/A			N/A			N/A			109,235			4.6	%(2)
Non-Agency RMBS			469,983			(47,224	)		(79,898	)		342,861			7,857			350,718			2.5	%
Non-Agency RMBS Interest-Only Strips			N/A			N/A			N/A			7,420			70			7,490			5.2	%
Agency and Non-Agency CMBS			11,979			(3,446	)		—			8,533			996			9,529			1.6	%
CMBS Interest-Only Strips			N/A			N/A			N/A			16,682			(140	)		16,542			4.7	%(2)
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,663,848		$	122,184		$	(79,898	)	$	2,889,061		$	(144,709	)	$	2,853,587			3.6	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 4—Residential Mortgage-Backed Securities (Continued)




		December 31, 2012
		Principal Balance			Unamortized Premium (Discount), net			Discount Designated as Credit Reserve and OTTI			Amortized Cost			Unrealized Gain (Loss), net			Estimated Fair Value			Net Weighted Average Coupon(1)
Agency RMBS:
20-Year Mortgage		$	299,251		$	20,460		$			$	319,711		$	(827	)	$	318,884			3.2	%
30-Year Mortgage			4,180,104			352,378						4,532,482			17,489			4,549,971			3.7	%
CMO—Fixed-rate			66,000			9,776						75,776			(1,546	)		74,230			6.5	%
Agency Interest Only—Strips			N/A			N/A						176,093			(1,057	)		175,036			4.5	%(2)
Agency Interest-Only Strips, accounted for as derivatives(3)			N/A			N/A						N/A			N/A			75,387			4.9	%(2)
Non-Agency RMBS			37,372			(5,511	)		(12,659	)		19,202			(129	)		19,073			0.5	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	4,582,727		$	377,103		$	(12,659	)	$	5,123,264		$	13,930		$	5,212,581			3.9	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Net weighted average coupon as of December 31, 2013 and December 31, 2012 is presented, net of servicing and other fees.



(2)

Agency and Non-Agency Interest-Only Strips, accounted for as derivatives and CMBS Interest-Only Strips have no principal balances and earn contractual interest based on a notional balance. The notional balance is used solely to determine interest distributions on interest-only class of securities.



(3)

Interest on these securities is reported as a component of Gain (loss) on derivative instruments, net on the Statement of Operations.

        As of December 31, 2013 the weighted average expected remaining term to the expected maturity of the investment portfolio, excluding linked transactions is 8.5 years.

        The components of the carrying value of the Company's investment portfolio are as followsfollows:

		December 31, 2013			December 31, 2012
Principal balance		$	2,663,848		$	4,582,727
Amortized cost of Interest-Only Strips			182,927			176,093
Carrying value of Agency and Non-Agency Interest-Only Strips accounted for as derivatives			109,235			75,387
Unamortized premium			183,324			382,614
Unamortized discount			(61,140	)		(5,511	)
Discount designated as Credit Reserve and OTTI			(79,898	)		(12,659	)
Gross unrealized gains			19,798			25,395
Gross unrealized losses			(164,507	)		(11,465	)
​	​	​	​	​	​	​	​
Fair value		$	2,853,587		$	5,212,581
​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 4—Mortgage-Backed Securities (Continued)

        The following tables present the changes in the components of the Company's purchase discount and amortizable premium on its Non-Agency RMBS for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012 (dollars in thousands):

		Year ended December 31, 2013
		Discount Designated as Credit Reserve and OTTI			Accretable Discount(1)			Amortizable Premium
Balance at beginning of period		$	(12,659	)	$	(5,523	)	$	12
Accretion of discount			—			10,722			—
Amortization of premium			—			—			(2,001	)
Realized credit losses			541			—			—
Purchases			(133,242	)		(89,697	)		35,416
Sales			81,144			34,894			(20,709	)
Net impairment losses recognized in earnings			(550	)		—			—
Unlinking of Linked Transactions			(21,986	)		(6,922	)		3,438
Transfers/release of credit reserve			6,854			(11,323	)		4,469
​	​	​	​	​	​	​	​	​	​	​
Balance of end of period		$	(79,898	)	$	(67,849	)	$	20,625
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

---

		December 31, 2012
Principal balance		$	4,582,727
Amortized cost of IOs and IIOs			176,093
Carrying value of Agency Interest-Only Strips accounted for as derivatives			75,387
Unamortized premium			382,614
Unamortized discount			(5,511	)
Non-Accretable discount			(12,659	)
Gross unrealized gains			25,395
Gross unrealized losses			(11,465	)
Fair value		$	5,212,581

(1)

Together with coupon interest, accretable purchase discount and amortizable premium is recognized as interest income over the life of the security.

		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
		Discount Designated as Credit Reserve and OTTI			Accretable Discount(1)			Amortizable Premium
Balance at beginning of period		$	—		$	—		$	—
Accretion of discount			—			123			—
Amortization of premium			—			—			—
Realized credit losses			—			—			—
Purchases			(12,659	)		(5,634	)		—
Sales			—			—			—
Net impairment losses recognized in earnings			—			—			—
Unlinking of Linked Transactions			—			—			—
Transfers/release of credit reserve			—			(12	)		12
​	​	​	​	​	​	​	​	​	​	​
Balance of end of period		$	(12,659	)	$	(5,523	)	$	12
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

---

(1)

Together with coupon interest, accretable purchase discount and amortizable premium is recognized as interest income over the life of the security.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 4—Mortgage-Backed Securities (Continued)

        As of December 31, 2012,The following tables present the Company held Agency RMBS with agross unrealized losses and estimated fair value of approximately $1.7 billionthe Company's MBS by length of time that such securities have been in ana continuous unrealized loss position of approximately $11.3 million. As ofat December 31, 2012, the Company held Non-Agency RMBS with a fair value of approximately $14.6 million in an unrealized loss position of approximately $136 thousand. As of December 31, 2012, the Company held no investments in an unrealized loss position for greater than one year.2013:

		Less than 12 Months									12 Months or More									Total
		Fair Value			Unrealized Losses			Number of Securities			Fair Value			Unrealized Losses			Number of Securities			Fair Value			Unrealized Losses			Number of Securities
Agency RMBS:
20-Year Mortgage		$	395,979		$	(21,466	)		52		$	106,947		$	(8,129	)		8		$	502,926		$	(29,595	)		60
30-Year Mortgage			1,242,871			(94,688	)		151			439,811			(33,328	)		26			1,682,682			(128,016	)		177
Agency Interest-Only Strips			69,773			(4,210	)		19			—			—			—			69,773			(4,210	)		19
Non-Agency RMBS			104,706			(2,546	)		18			—			—			—			104,706			(2,546	)		18
Agency and Non-Agency CMBS			16,542			(140	)		3			—			—			—			16,542			(140	)		3
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	1,829,871		$	(123,050	)		243		$	546,758		$	(41,457	)		34		$	2,376,629		$	(164,507	)		277
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

        At December 31, 2012,2013, the Company did not intend to sell any of its RMBSMBS that were in an unrealized loss position, and it is "more likely than not" that the Company will not be required to sell these RMBSMBS before recovery of their amortized cost basis, which may be at their maturity.

        The Company assesses its Agency RMBSMBS and Non-Agency MBS, excluding Interest-Only Strips, rated AA and higher at the time of purchase for other-than-temporary impairment on at least a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either "temporary" or "other-than-temporary." In deciding on whether or not a security is other than temporarilyother-than-temporarily impaired, the Company considers several factors, including the nature of the investment, communications (if any) from the trustees of securitizations regarding the credit quality of the security, the severity and duration of the impairment, the cause of the impairment, and the Company's intent not to sell the security and that it is more likely than not that the Company can holdwill not be required to sell the security until recovery of its cost basis.amortized cost. In addition, an other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the security is less than its carrying amount. In determining whether an adverse change in cash flows occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The Company's prepayment speed estimate isestimated cash flows reflect those a "market participant" would use and are discounted at a rate equal to the primary assumptioncurrent yield used to determine other than temporary impairments for the period from May 15, 2012 (commencement of operations) through December 31, 2012. The Company recorded other than temporary impairments for the period from May 15, 2012 (commencement of operations) through December 31, 2012 of $3.2 million with is reported as other loss on RMBS and other securities, netaccrete interest income. These adjustments are reflected in the Company's statementStatement of operations.Operations as Other loss on Mortgage-backed securities.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 4—Residential Mortgage-Backed Securities (Continued)

        For Non-Agency RMBSMBS that are purchased at a discount to par value and/or are rated below AA at the time of purchase and Agency and Non-Agency Interest-Only Strips, that are notexcluding Interest-Only Strips classified as derivatives, an other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the beneficial interest is less than its carrying amount. Other than for "plain-vanilla" variable rate Non-Agency MBS the Company does not bifurcate the loss between credit loss and loss attributed to change in interest rates, therefore, the entire loss is recorded as other-than-temporary. These adjustments are reflected in the Company's Statement of Operations as Other loss on Residential mortgage-backedMortgage-backed securities. In determining whether an adverse change in cash flows occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those a "market participant" would use and are discounted at a rate equal to the current yield used to accrete interest income.

If an other-than-temporary impairment is recognized as a result of this analysis, the yield is maintained at the current accretion rate. The following tables present componentslast revised estimated cash flows are then used for future impairment analysis purposes. The Company's prepayment speed estimate is the primary assumption used to determine other-than temporary-impairments for Interest-Only Strips, excluding Agency and Non-Agency Interest-Only Strips accounted for as derivatives, for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of interest income on the Company's Agency RMBS (dollars in thousands).operations) through December 31, 2012.

		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
		Coupon Interest			Net (Premium Amortization/ Amortization Basis) Discount Accretion			Interest Income
Agency RMBS			80,093			(26,908	)		53,185
Non-Agency RMBS			10			123			133
Total			80,103			(26,785	)		53,318

        The Company sold Agency RMBSrecorded other-than-temporary-impairments for the year ended December 31, 2013 of approximately $11.3 million and other securities duringapproximately $3.2 million for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively, for grossAgency IOs, Agency IIOs and 20-year Agency RMBS. The Company recorded approximately $550 thousand of other-than-temporary impairments for the year ended December 31, 2013 and $0 for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively for Non-Agency MBS. The Company recorded approximately $8 thousand of other-than-temporary-impairments for the year ended December 31, 2013 and $0 for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively for CMBS Interest-Only Strips. Other-than-temporary-impairments are reported as Other loss on Mortgage-backed securities in the Company's Statement of Operations.

        The following tables present components of interest income on the Company's MBS (dollars in thousands).

		For the year ended December 31, 2013
		Coupon Interest			Net (Premium Amortization/ Amortization Basis) Discount Amortization			Interest Income
Agency RMBS		$	172,171		$	(60,320	)	$	111,851
Non-Agency RMBS			4,757			8,282			13,039
Agency and Non-Agency CMBS			544			(106	)		438
​	​	​	​	​	​	​	​	​	​	​
Total		$	177,472		$	(52,144	)	$	125,328
​	​	​	​	​	​	​	​	​	​	​




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 4—Mortgage-Backed Securities (Continued)




		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
		Coupon Interest			Net (Premium Amortization/ Amortization Basis) Discount Amortization			Interest Income
Agency RMBS		$	80,093		$	(26,908	)	$	53,185
Non-Agency RMBS			10			123			133
​	​	​	​	​	​	​	​	​	​	​
Total		$	80,103		$	(26,785	)	$	53,318
​	​	​	​	​	​	​	​	​	​	​

        The following tables present the sales of the Company's MBS (dollars in thousands).

		For the year ended December 31, 2013
		Proceeds			Gross Gains			Gross Losses			Net Gain (Loss)
Agency RMBS(1)		$	3,491,805		$	8,646		$	(127,252	)	$	(118,606	)
Non-Agency RMBS			128,683			7,146			(376	)		6,770
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	3,620,488		$	15,792		$	(127,628	)	$	(111,836	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Includes proceeds for Agency Interest-Only Strips, accounted for as derivatives, of approximately $2.5 billion realizing net gains of approximately $19.9 million, comprised of gross gains of approximately $23.4$20.4 million and gross realized losses of $1.1 million.

		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
		Proceeds			Gross Gains			Gross Losses			Net Gain (Loss)
Agency RMBS(1)		$	2,389,472		$	23,169		$	(3,434	)	$	19,735
Other Securities			100,854			199			—			199
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,490,326		$	23,368		$	(3,434	)	$	19,934
​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Includes proceeds for Agency Interest-Only Strips, accounted for as derivatives, of approximately $3.4 million.$18.5 million and gross realized losses of $820 thousand.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 5—Borrowings under Repurchase Agreements

        As of December 31, 2012,2013, the Company had master repurchase agreements with 14 counterparties, and was in discussions with additional counterparties, to finance substantially its entire Agency RMBS portfolio.20 counterparties. As of December 31, 2012,2013, the Company had borrowings under repurchase agreements with 1416 counterparties. The following tables summarize certain characteristics of the Company's repurchase agreements at December 31, 2013 and December 31, 2012 (dollars in thousands):

		December 31, 2013
Securities Pledged		Repurchase Agreement Borrowings			Weighted Average Interest Rate on Borrowings Outstanding at end of period			Weighted Average Remaining Maturity (days)
Agency RMBS		$	2,331,276			0.43	%		24
Non-Agency RMBS			230,247			1.71	%		18
Agency and Non-Agency CMBS			17,544			1.33	%		58
​	​	​	​	​	​	​	​	​	​	​
Total		$	2,579,067			0.55	%		24
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​




		December 31, 2012
Securities Pledged		Repurchase Agreement Borrowings			Weighted Average Interest Rate on Borrowings Outstanding at end of period			Weighted Average Remaining Maturity (days)
Agency RMBS		$	4,794,730			0.48	%		19
​	​	​	​	​	​	​	​	​	​	​
Total		$	4,794,730			0.48	%		19
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

        For the year ended December 31, 2013, the Company had average borrowings under its repurchase agreements of approximately $3.8 billion, had a maximum month-end balance during the period of approximately $4.8 billion. The Company had accrued interest payable at December 31, 2013 of approximately $1.7 million. For the period from May 15, 2012 (commencement of operations) through December 31, 2012, the Company had average borrowings under its repurchase agreements of approximately $2.9 billion, and had a maximum month-end balance during the period of approximately $4.9 billion.billion and accrued interest payable of approximately $3.5 million.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 5—Borrowings under Repurchase Agreements (Continued)

        The repurchase agreements bear interest at a contractually agreed-upon rate and typically have terms ranging from one month to three months. The Company's repurchase agreement borrowings are accounted for as secured borrowings given thatwhen the Company maintains effective control of the financed assets. Under the repurchase agreements, the respective lender retains the right to determine the fair value of the underlying collateral. A reduction in the value of pledged assets requires the Company to post additional securities as collateral, pay down borrowings or establish cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements, referred to as margin calls. The inability of the Company to post adequate collateral for a margin call by the counterparty, in a timeframe as short as the close of the same business day, could result in a condition of default under the Company's repurchase agreements, thereby enabling the counterparty to liquidate the collateral pledged by the Company, which may have ana material adverse effect on the Company's financial condition andposition, results of operations.operations and cash flows. During 2013, the volatility in both the Agency and Non-Agency MBS markets necessitated the Company being required to post additional collateral with respect to its repurchase agreements. The Company was able to satisfy the requirement for incremental collateral by utilizing unpledged assets and cash on hand. In addition, during the second and third quarters of 2013, the Company also rehypothecated pledged U.S. Treasury securities it received from its interest rate swap counterparties as incremental collateral in order to generate additional cash proceeds in order to satisfy such margin requirements. The maximum amount of repurchase borrowings for the rehypothecated securities was $130.7 million during the year ended December 31, 2013. At December 31, 2013, the Company did not have any rehypothecated U.S. Treasury securities.

        Continued volatility in these markets may create additional stress on the overall liquidity of the Company due to the long-term nature of its assets and the short-term nature of its liabilities. In an instance of severe volatility, or where the additional stress on liquidity resulting from volatility is sustained over an extended period of time, the Company could be required to sell securities, possibly even at a loss, to generate sufficient liquidity to satisfy collateral and margin requirements which could have a material adverse effect on the Company's financial position, results of operations and cash flows. All of the Company's repurchase agreement counterparties are either U.S. financial institutions or the U.S. broker-dealer subsidiaries of foreign financial institutions.

        Further, if the Company is unable to renew, replace or expand repurchase financing with other sources of financing on substantially similar terms it may have ana material adverse effect on the Company's business andfinancial position, results of operations and cash flow, due to the long term nature of the Company's investments and relatively short-term maturities of the Company's repurchase agreements. The financial covenants of certain of the repurchase agreements require the Company to maintain certain equity and leverage metrics, the most restrictive of which include a limit on leverage based on the composition of the Company's portfolio. The




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 5—Borrowings under Repurchase Agreements (Continued)

        In reviewing its various master repurchase agreements, the Company determined that at June 30, 2013, the ratio of its Agency MBS to Total Assets was approximately 89.6%, which, if unrounded, was below a 90% threshold for such ratio as determined by the Company's then current leverage ratio contained in two of the Company's master repurchase agreements (only one of which had transactions then outstanding). If such ratio is determined to be below the required threshold, the counterparties to the master repurchase agreements may elect to seek to terminate existing repurchase transactions under the master repurchase agreements. In addition to previously providing such counterparties with its financial documents, the Company, in March 2014 provided each counterparty with specific notice with regard to the June 30, 2013 calculation. To date, both counterparties have continued to fund and enter into new repo transactions with the Company and at both September 30, 2013 and December 31, 2013 the Company exceeded any applicable asset ratios. Neither of the counterparties has indicated any intention to seek to terminate any existing repurchase agreements. Further, as previously stated, repo financing does not represent a committed facility and, accordingly, any repo counterparty can elect to cease providing the Company financing at any time for any reason. Thus any early termination would have only a short term impact on the Company's legal rights. While the Company does not expect any of the aforementioned counterparties to do so, based on its analysis, the Company believes it has sufficient liquidity and alternative financing sources, primarily other repo financing providers, to finance its portfolio and continue to operate its business in the normal course and for the foreseeable future regardless if either or both such counterparties elect to terminate their financing relationships with the Company. At December 31, 2013, the Company is in compliance with these covenants for the period from May 15, 2012 (commencement of operations) through December 31, 2012 and at December 31, 2012.covenants.

        The following table summarizes certain characteristics of the Company's repurchase agreements at December 31, 2012 (dollars in thousands):

RMBS Pledged		Repurchase Agreement Borrowings			Weighted Average Interest Rate on Borrowings Outstanding at end of period			Weighted Average Remaining Maturity (days)
Agency RMBS		$	4,794,730			0.48	%		19
Total		$	4,794,730			0.48	%		19

        At December 31, 2012,2013, repurchase agreements collateralized by RMBSMBS had the following remaining maturities.

(dollars in thousands)		Balance				Balance
Overnight		$	—			$	323,025
1 to 29 days			4,046,307				1,393,356
30 to 59 days			263,981				799,391
60 to 89 days			484,442				63,295
90 to 119 days			—				—
Greater than or equal to 120 days			—				—
​					​		​	​
Total		$	4,794,730			$	2,579,067
​					​		​	​
​					​		​	​

        As discussed in Note 2, for any transactions determined to be linked, the initial transfer and repurchase financing will be recorded as a forward commitment to purchase assets. At December 31, 2013, the Company had repurchase agreements of approximately $61.2 million that were accounted for as linked transactions. At December 31, 2012, the Company had no transactions determined to be linked. Linked repurchase agreements are not included in the tables above. See Note 7 for details.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 5—Borrowings under Repurchase Agreements (Continued)

        At December 31, 2012,2013, the Company did not have an amountfollowing table reflects amounts of collateral at risk under its repurchase agreements greater than 10% of itsthe Company's equity with any counterparty.counterparty, including linked transactions.

		December 31, 2013 (dollars in thousands)
Counterparty		Amount Collateral at Risk, at fair value			Weighted Average Remaining Maturity (days)			Percentage of Stockholders' Equity
Credit Suisse Securities (USA) LLC		$	58,442			25			14.3	%
Barclays Capital Inc.			54,029			14			13.2
JP Morgan Securities LLC			47,112			1			11.5

Note 6—Collateral Positions

        The following tables summarize the Company's collateral positions, with respect to its borrowings under repurchase agreements, derivatives and clearing margin account at December 31, 2013 and December 31, 2012 (dollars in thousands):

												December 31, 2013
		Assets Pledged—Fair Value			Accrued Interest			Fair Value of Assets Pledged and Accrued Interest				Assets Pledged—Fair Value			Accrued Interest			Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
Agency RMBS		$	5,043,824		$	67,551		$	5,111,375			$	2,463,347		$	10,453		$	2,473,800
Non-Agency RMBS													332,003			443			332,446
Agency and Non-Agency CMBS													23,597			159			23,756
Cash(1)			35,982						35,982				32,597			—			32,597
Cash collateral for derivatives(1):			18,160						18,160				22,837			—			22,837
​											​		​	​		​	​		​	​
Total		$	5,097,966		$	67,551		$	5,165,517			$	2,874,381		$	11,055		$	2,885,436
​											​		​	​		​	​		​	​
​											​		​	​		​	​		​	​




		December 31, 2012
		Assets Pledged—Fair Value			Accrued Interest, as Revised(2)			Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
Agency RMBS		$	5,043,824		$	15,552		$	5,059,376
Cash(1)			35,982			—			35,982
Cash collateral for derivatives(1):			18,160			—			18,160
​	​	​	​	​	​	​	​	​	​	​
Total		$	5,097,966		$	15,552		$	5,113,518
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

---

(1)

Cash posted as collateral is included in Due from counterparties on the Company's balance sheet.Balance Sheets.



        A reduction

(2)
The accrued interest related to Agency RMBS was incorrectly disclosed as $67,551 in the value of pledged assets typically results in the repurchase agreement counterparties, derivative counterpartiesCompany's 2012 10-K, and clearing margin counterparties initiating a daily margin call. At December 31, 2012, Agency RMBS held by counterparties as security for repurchase agreements totaled approximately $5.0 billion. Cash collateral held by counterparties at December 31, 2012 was approximately $54.1 million.
Note 7—Derivative Instruments
        The Company's derivatives currently include interest rate swaps ("interest rate swaps"), interest rate swaptions, TBAs and Agency Interest-Only Strips that are classified as derivatives.
has been revised above.



Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 6—Collateral Positions (Continued)

        A reduction in the value of pledged assets typically results in the repurchase agreement counterparties, derivative counterparties and clearing margin counterparties initiating a daily margin call. At December 31, 2013 and December 31, 2012, MBS held by counterparties as security for repurchase agreements totaled approximately $2.8 billion and approximately $5.0 billion, respectively. Cash collateral held by counterparties at December 31, 2013 and December 31, 2012 was approximately $55.4 million and $54.1 million, respectively. Cash posted by counterparties at December 31, 2013 and December 31, 2012, was approximately $65.9 million and $0, respectively. In addition, at December 31, 2013 and December 31, 2012, the Company held securities of approximately $0 and $2.6 million, respectively, received as collateral from its repurchase agreement counterparties to satisfy margin requirements.

Note 7—Derivative Instruments (Continued)

        The Company's derivatives currently include interest rate swaps ("interest rate swaps"), interest rate swaptions, TBAs, linked transactions, Agency and Non-Agency Interest-Only Strips that are classified as derivatives, and options.

Interest rate swaps and interest rate swaptions

        The Company is exposed to certain riskrisks arising from both its business operations and economic conditions. Specifically, the Company's primary source of debt funding is repurchase agreements and the Company enters into derivative financial instruments to manage exposure to variable cash flows on portions of its borrowings under those repurchase agreements. Since the interest rates on repurchase agreements typically change with market interest rates such as the London interbank offered rate or LIBOR, the Company is exposed to constantly changing interest rates, which accordingly affects cash flows associated with these rates on its borrowings. To mitigate the effect of changes in these interest rates, the Company enters into interest rate swap agreements which help to mitigate the volatility in the interest rate exposures and their related cash flows. Interest rate swaps generally involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the interest rate swap without exchange of the underlying notional amount. Notwithstanding the foregoing, in order to manage its hedge position with regard to its liabilities, the Company on occasion will enter into interest rate swaps which involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the interest rate swap without exchange of the underlying notional amount.

        While the Company has not elected to account for its interest rate swap derivative instruments as "hedges" under GAAP, it does not use derivativesinterest rate swaps and swaptions for speculative purposes, but rather uses such instruments to manage interest rate risk and views them as economic hedges. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings together with or including periodic net interest settlement amounts.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 7—Derivative Instruments (Continued)

        During the year ended December 31, 2013, the Company de-levered its balance sheet in order to take advantage of attractive valuations in the Non-Agency RMBS and CMBS. In addition to selling Agency MBS pass through securities, the Company reduced its borrowings under repurchase agreements and adjusted its interest rate swap holdings by terminating approximately $2.8 billion notional amount. This resulted in a net realized gain on derivative instruments of approximately $65.3 million. . In addition, during the year, the Company entered into swaptions which resulted in a net realized gain on derivative instruments of approximately $ 26.7 million. The Company's interest rate swap,swaps, interest rate swaptions, and TBA derivative instruments and linked transactions consisted of the following at December 31, 2013 and December 31, 2012 (dollars in thousands):

						December 31, 2013
Derivative Instrument		Designation		Balance Sheet Location		Notional Amount			Fair Value, excluding accrued interest			Accrued Interest Payable
Interest rate swaps, assets		Non-Hedge		Derivative assets, at fair value		$	2,135,950		$	94,614		$	9,994
Interest rate swaptions, assets		Non-Hedge		Derivative assets, at fair value			2,200,000			11,177			—
TBA securities, assets		Non-Hedge		Derivative assets, at fair value			13,600			35			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total derivative instruments, assets							4,349,550			105,826			9,994
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Interest rate swaps, liability		Non-Hedge		Derivative liability, at fair value			678,900			(3,202	)		(26	)
Interest rate swaptions, liability		Non-Hedge		Derivative liability, at fair value			100,000			(264	)		—
TBA securities, liabilities		Non-Hedge		Derivative liability, at fair value			176,400			(1,207	)		—
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total derivative instruments, liabilities							955,300			(4,673	)		(26	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Linked transactions(1)		Non-Hedge		Linked transactions, net, at fair value			56,028			18,559			(207	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total derivative instruments						$	5,360,878		$	119,712		$	9,761
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Notional amount represents the current face of the securities comprising the linked transactions.

		Notional Amount			Fair Value, excluding accrued interest			Accrued Interest								December 31, 2012
Derivative Instrument												Designation		Balance Sheet Location		Notional Amount			Fair Value, excluding accrued interest			Accrued Interest Payable
Interest rate swaps, assets		$	1,827,300		$	11,201		$	2,519			Non-Hedge		Derivative assets, at fair value		$	1,827,300		$	11,201		$	2,519
Interest rate swaptions, assets			520,000			10,087			—			Non-Hedge		Derivative assets, at fair value			520,000			10,087			—
TBA securities, assets			425,000			3,056			—			Non-Hedge		Derivative assets, at fair value			425,000			3,056			—
​											​	​	​	​	​		​	​		​	​		​	​
Total derivative instruments, assets			2,772,300			24,344			2,519								2,772,300			24,344			2,519
​											​	​	​	​	​		​	​		​	​		​	​
Interest rate swaps, liabilities			984,500			(3,552	)		588			Non-Hedge		Derivative liability, at fair value			984,500			(3,552	)		588
TBA securities, liabilities			425,000			(1,219	)		—			Non-Hedge		Derivative liability, at fair value			425,000			(1,219	)		—
​											​	​	​	​	​		​	​		​	​		​	​
Total derivative instruments, liabilities			1,409,500			(4,771	)		588								1,409,500			(4,771	)		588
​											​	​	​	​	​		​	​		​	​		​	​
Total derivative instruments		$	4,181,800		$	19,573		$	3,107							$	4,181,800		$	19,573		$	3,107
​											​	​	​	​	​		​	​		​	​		​	​
​											​	​	​	​	​		​	​		​	​		​	​




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 7—Derivative Instruments (Continued)

        The following table summarizestables summarize the average fixed pay rate and average maturity for the Company's interest rate swaps as of December 31, 2013 and December 31, 2012 (excludes interest rate swaptions) (dollars in thousands):

															December 31, 2013
Remaining Interest Rate interest rate swap Term		Notional Amount			Average Fixed Pay Rate			Average Maturity (Years)			Forward Starting				Notional Amount			Average Fixed Pay Rate			Average Maturity (Years)			Forward Starting
1 year or less															$	215,900			0.4	%		0.8			—	%
Greater than 1 year and less than 3 years		$	762,800			0.4	%		2.3			22.7	%			179,100			0.5			1.9			—
Greater than 3 years and less than 5 years			439,500			0.8			4.8			10.2				574,200			1.3			4.4			—
Greater than 5 years			1,609,500			1.7			10.2			30.1				1,718,650			2.4			10.8			28.6
​														​		​	​		​	​		​	​		​	​
Total		$	2,811,800			1.2	%		7.2			25.0	%		$	2,687,850			1.9	%		8.0			18.3	%
​														​		​	​		​	​		​	​		​	​
​														​		​	​		​	​		​	​		​	​




		December 31, 2012
Remaining Interest Rate interest rate swap Term		Notional Amount			Average Fixed Pay Rate			Average Maturity (Years)			Forward Starting
Greater than 1 year and less than 3 years		$	762,800			0.4	%		2.3			22.7	%
Greater than 3 years and less than 5 years			439,500			0.8			4.8			10.2
Greater than 5 years			1,609,500			1.7			10.2			30.1
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	2,811,800			1.2	%		7.2			25.0	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

        The following tables summarize the average variable pay-rate and average maturity for the Company's interest rate swaps as of December 31, 2013 (excludes interest rate swaptions) (dollars in thousands), the Company had no variable pay rate swaps at December 31, 2012:

		December 31, 2013
Remaining Interest Rate interest rate swap Term		Notional Amount			Average Variable Pay Rate			Average Maturity (Years)			Forward Starting
Greater than 3 years and less than 5 years		$	81,000			0.2	%		4.8			—	%
Greater than 5 years			46,000			0.2			24.1			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	127,000			0.2	%		11.8			—	%
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

        The Company's agreements with certain of its bilateral interest rate swap counterparties may be terminated at the option of the counterparty if the Company does not maintain certain equity and leverage metrics, the most restrictive of which contain provisions which become more restrictive based upon portfolio composition. Through December 31, 2012,2013, the Company was in compliance with the terms of such financial tests.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 7—Derivative Instruments (Continued)

        At December 31, 2012,2013, the Company had entered into twosix swaptions with notional amounts ranging from $100.0 million to $1.5 billion which expire from May 1, 2014 and October 28, 2014. If exercised, the Company can enter into seven year and ten year fixed pay swap agreement, at a predetermined strike price. At December 31, 2013 the Company had also entered into a swaption with a notional amount of $445.0 million and $75.0$100.0 million that expireexpires in nine months and seven months, respectively.May 1, 2014. If either is exercised, the Company can enter into a 20ten year fixedvariable pay swap agreement and a 10 year fixed pay swap agreement, respectively at a predetermined strike price.agreement.

        The Company has minimum collateral posting thresholds with certain of its derivative counterparties, including with its clearing broker for cleared swaps, for which it typically pledges cash. As of December 31, 2013 and December 31, 2012, the Company had cash pledged as collateral of approximately $22.8 million and $18.2 million, respectively, which is reported on the balance sheetBalance Sheet as Due from counterparties. The Company received cash of approximately $62.7 million and $0 as collateral against derivatives at December 31, 2013 and December 31, 2012, respectively. As of December 31, 2013, the Company has swaps with two counterparties that are based in England and Switzerland, with fair valuevalues in an asset position of approximately $19.4 million and $34.2 million and notional balances of $321.8 million and $825.1 million, respectively. Included in the $62.7 million received by the Company is cash posted as collateral by these two counterparties of approximately $42.7 million at December 31, 2013. At December 31, 2012, the Company had swaps with fair values in an asset position of $681 thousand and $280 thousand and notional balances of $572.0 million and $1.4 billion with these two counterparties that are based in England and Switzerland, respectively.counterparties. In addition, at December 31, 2012, the Company posted approximately $6.6 million cash as collateral to these two counterparties.

Agency Interest-Only Strips

        The Company also invests in Agency Interest-Only Strips. The Company has evaluatedIn determining the terms and conditionsclassification of its holdings of Agency Interest-Only Strips, the Company evaluates the securities to determine if these instruments having the characteristicsnature of investments or wouldthe cash flows has been altered from that of the underlying mortgage collateral. Generally, Interest-Only Strips for which the security represents a strip off of a mortgage pass through will be considered derivatives under GAAP. Accordingly, Agencya hybrid instrument classified as a MBS investment on the Balance Sheet utilizing the fair value option. Alternatively, those Interest-Only Strips, havingfor which the characteristics of derivatives haveunderlying mortgage collateral has been included into a structured security that alters the cash flows from the underlying mortgage collateral, are accounted for as derivatives at fair value with changes in recognized in LossGain (loss) on derivative instruments, net in the Statement of Operations, along with any interest received. The carrying value of these Agency Interest-Only Strips is included in Residential mortgage-backedMortgage-backed securities on the balance sheet.Balance Sheet.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 7—Derivative Instruments (Continued)

To-be-announced securities

        The Company also purchased or shorted TBAs. As of December 31, 2013 and December 31, 2012, the Company had contracts to purchase ("long position") and sell ("short position") TBAs on a forward basis. Following is a summary of ourthe Company's long and short TBA positions reported in Derivative assets, at fair value on the balance sheetBalance Sheet as of December 31, 2013 and December 31, 2012 (dollars in thousands):

		Notional Amount			Fair Value
Purchase contracts		$	425,000		$	3,056
Sale contracts			(425,000	)		1,219
TBA securities, net		$	—		$	1,837

		December 31, 2013						December 31, 2012
		Notional Amount			Fair Value			Notional Amount			Fair Value
Purchase contracts, asset		$	13,600		$	35		$	425,000		$	3,056
​	​	​	​	​	​	​	​	​	​	​	​	​	​
TBA securities, asset			13,600			35			425,000			3,056
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Purchase contracts, liability			176,400			(1,207	)		—			—
Sale contracts, liability			—			—			(425,000	)		(1,219	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​
TBA securities, liability			176,400			(1,207	)		(425,000	)		(1,219	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​
TBA securities, net		$	190,000		$	(1,172	)	$	—		$	1,837
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

 


		Notional Amount as May 15, 2012 (commencement of operations)			Additions			Settlement, Termination, Expiration or Exercise			Notional Amount as of December 31, 2012				Notional Amount as of December 31, 2012			Additions			Settlement, Termination, Expiration or Exercise			Notional Amount as of December 31, 2013
Purchase of TBAs		$	—		$	425,000		$	—		$	425,000			$	425,000			2,507,600		$	(2,742,600	)	$	190,000
Sale of TBAs		$	—		$	425,000		$	—		$	425,000			$	425,000			2,350,000		$	(2,775,000	)	$	—

Gain (loss) on derivative instruments

        The below table summarizes the effect of interest rate swaps, swaptions, options, Agency and Non-Agency Interest-Only Strips as derivatives and TBAs reported in Other LossGain (loss) on derivative instruments, net on our statementStatement of operationsOperations for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012:2012 (dollars in thousands):

															Year ended December 31, 2013
Description		Realized Gain (Loss), net(1)			Contractual interest income (expense), net			Mark-to-market adjustments			Total				Realized Gain (Loss), net			Contractual interest income (expense), net(1)			Basis Recovery			Mark-to- market adjustments			Total
Interest rate swaps		$	(10,928	)	$	(6,321	)	$	7,649		$	(9,600	)		$	65,305		$	(22,932	)	$	—		$	83,764		$	126,137
Interest rate swaptions									(3,180	)		(3,180	)			23,671			—			—			4,733			28,404
Agency Interest-Only Strips and Agency Inverse Interest-Only Strips—accounted for as derivatives			(820	)		8,570			(9,913	)		(2,163	)
Agency and Non-Agency Interest-Only Strips—accounted for as derivatives																(1,124	)		28,273			(18,010	)		(700	)		8,439
Options																(925	)		—			—			—			(925	)
TBAs			—			—			1,837			1,837				(1,499	)		—			—			(3,009	)		(4,508	)
​														​		​	​		​	​		​	​		​	​		​	​
Total		$	(11,748	)	$	2,249		$	(3,607	)	$	(13,106	)		$	85,428		$	5,341		$	(18,010	)	$	84,788		$	157,547
​														​		​	​		​	​		​	​		​	​		​	​
​														​		​	​		​	​		​	​		​	​		​	​




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 7—Derivative Instruments (Continued)




		For the period from May 15, 2012 (commencement of operations) through December 31, 2012
Description		Realized Gain (Loss), net			Contractual interest income (expense), net(1)			Basis Recovery			Mark-to- market adjustments			Total
Interest rate swaps		$	(10,928	)	$	(6,321	)	$	—		$	7,649		$	(9,600	)
Interest rate swaptions			—			—			—			(3,180	)		(3,180	)
Agency Interest-Only Strips—accounted for as derivatives			(820	)		8,570			(4,848	)		(5,065	)		(2,163	)
Options			—			—			—			—			—
TBAs			—			—			—			1,837			1,837
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	(11,748	)	$	2,249		$	(4,848	)	$	1,241		$	(13,106	)
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received.

Linked Transactions

        As discussed in Note 2, when the initial transfer of a financial asset and repurchase financing are entered into contemporaneously with, or in contemplation of, one another, the transaction will be considered linked unless all of the criteria found in the applicable accounting guidance are met at the inception of the transaction. If the transaction is determined to be linked, the Company records the initial transfer and repurchase financing on a net basis and records a forward commitment to purchase assets as a derivative instrument with changes in market value being recorded in the Gain (loss) on linked transactions, net on the Statement of Operations. While linked transactions are treated as derivatives for GAAP, the fair value of linked transactions reflects the value of the underlying security's fair market value netted with the respective linked repurchase agreement borrowings. The Company had no linked transactions at December 31, 2012.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 7—Derivative Instruments (Continued)

        The following table presents certain information related to the securities and repurchase agreements accounted for as part of linked transaction which is reported in Linked transactions, net, at fair value on the Balance Sheet at December 31, 2013 and Gain (loss) on linked transactions, net on the Statement of Operations for the year ended December 31, 2013 (dollars in thousands):

					For the Year Ended December 31, 2013															Weighted Average Life (years)/ Weighted Average days to Maturity(2)
Instrument		Fair Value(2)			Net Interest Income(1) (Expense)			Mark-to-market adjustments on linked transactions			Net Realized Gain (loss)			Gain (loss) on linked transactions, net			Weighted Average Coupon / Cost of Funds(2)
Agency RMBS		$	—		$	44		$	—		$	(254	)	$	(210	)		n/a		n/a
Non-Agency RMBS			79,746			1,371			(56	)		3,303			4,618			27.06	%	9.6 years
Agency Repurchase Agreement			—			(6	)		—			—			(6	)		n/a		n/a
Non-Agency Repurchase Agreement			(61,187	)		(265	)		—			—			(265	)		1.70	%	63 days
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Linked transactions, net, at fair value		$	18,559		$	1,144		$	(56	)	$	3,049		$	4,137			n/a		n/a
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Net interest income includes amortization of premium of $9 thousand for Agency RMBS and accretion of discount of $555 thousand for Non-Agency RMBS.



(2)

Includes information only for linked transactions at December 31, 2013.

        The Company pledged MBS accounted for as linked transactions with a fair value of approximately $79.7 million as collateral for the related linked repurchase agreements. The Company reduces credit risk on the majority of its derivative instruments by entering into agreements that permit the closeout and netting of transactions with the same counterparty upon occurrence of certain events.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 8—Offsetting Assets and Liabilities

        The following tables present information about certain assets and liabilities that are subject to master netting agreements (or similar agreements) and can potentially be offset on the Company's Balance Sheets at December 31, 2013 and December 31, 2012:

Offsetting of Derivative Assets

As of December 31, 2013

											Gross Amounts Not Offset in the Balance Sheet
								Net Amounts of Assets presented in the Balance Sheet
$s in thousands Description		Gross Amounts of Recognized Assets			Gross Amounts Offset in the Balance Sheet						Financial Instruments(1)			Cash Collateral Received			Net Amount
Agency and Non-Agency Interest-Only Strips, accounted for as derivatives included in MBS		$	109,235		$	—		$	109,235		$	(109,235	)	$	—		$	—
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Derivative asset, at fair value			105,826			—			105,826			(3,501	)		(62,651	)		39,674
Linked transactions, net, at fair value			79,746			(61,187	)		18,859			—			—			18,559
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	294,807		$	(61,187	)	$	233,620		$	(112,736	)	$	(62,651	)	$	58,233
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

Offsetting of Derivative Liabilities and Repurchase agreements

As of December 31, 2013

											Gross Amounts Not Offset in the Balance Sheet
								Net Amounts of Liabilities presented in the Balance Sheet
$s in thousands Description		Gross Amounts of Recognized Liabilities			Gross Amounts Offset in the Balance Sheet						Financial Instruments(1)			Cash Collateral Pledged(1)			Net Amount
Derivative liability, at fair value(2)		$	4,673		$	—		$	4,673		$	(3,501	)	$	—		$	1,172
Repurchase Agreements(3)			2,579,067			—			2,579,067			(2,579,067	)		—			—
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
		$	2,583,740		$	—		$	2,583,740		$	(2,582,568	)	$	—		$	1,172
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Amounts disclosed in the Financial Instruments column of the table above represent securities collateral pledged that is available to be offset against liability balances associated with repurchase agreement and derivative transactions. Amounts disclosed in the Cash Collateral Pledged column of the table above represents amounts pledged as collateral against derivative transactions.



(2)

Cash collateral pledged against the Company's Swaps was approximately $22.8 million as of December 31, 2013.



(3)

The fair value of securities pledged against the Company's repurchase agreements was approximately $2.8 billion as of December 31, 2013.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 8—Offsetting Assets and Liabilities (Continued)

Offsetting of Derivative Assets

As of December 31, 2012

											Gross Amounts Not Offset in the Balance Sheet
								Net Amounts of Assets presented in the Balance Sheet
$s in thousands Description		Gross Amounts of Recognized Assets			Gross Amounts Offset in the Balance Sheet						Financial Instruments(1)			Cash Collateral Received			Net Amount
Agency Interest-Only Strips, accounted for as derivatives included in MBS		$	75,387		$	—		$	75,387		$	(46,686	)	$	—		$	28,701
Derivative asset, at fair value			24,344			—			24,344			(3,552	)		—			20,792
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	99,731		$	—		$	99,731		$	(50,238	)	$	—		$	49,493
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

Offsetting of Derivative Liabilities and Repurchase agreements

As of December 31, 2012

											Gross Amounts Not Offset in the Balance Sheet
								Net Amounts of Liabilities presented in the Balance Sheet
$s in thousands Description		Gross Amounts of Recognized Liabilities			Gross Amounts Offset in the Balance Sheet						Financial Instruments(1)			Cash Collateral Pledged(1)			Net Amount
Derivative liability, at fair value(2)		$	4,771		$	—		$	4,771		$	(3,552	)	$	—		$	1,219
Repurchase Agreements(3)			4,794,730			—			4,794,730			(4,794,730	)					—
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total		$	4,799,501		$	—		$	4,799,501		$	(4,798,282	)	$	—		$	1,219
​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

Amounts disclosed in the Financial Instruments column of the table above represent securities collateral pledged that is available to be offset against liability balances associated with repurchase agreement and derivative transactions. Amounts disclosed in the Cash Collateral Pledged column of the table above represents amounts pledged as collateral against derivative transactions.



(2)

Cash collateral pledged against the Company's Swaps was approximately $18.2 million at December 31, 2012.



(3)

The fair value of securities pledged against the Company's repurchase agreements was approximately $5.1 billion at December 31, 2012.

        Certain of the Company's repurchase agreement and derivative transactions are governed by underlying agreements that generally provide for a right of setoff in the event of default or in the event of a bankruptcy of either party to the transaction.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 9—Related Party Transactions

Management Agreement

        In connection with the Company's IPO in May 2012, the Company entered into a management agreement (the "Management Agreement") with the Manager, which describes the services to be provided by the Manager and compensation for such services. The Manager is responsible for managing the Company's operations, including: (i) performing all of its day-to-day functions other than those provided by the Company's chief financial officer;functions; (ii) determining investment criteria in conjunction with the board of directors; (iii) sourcing, analyzing and executing investments, asset sales and financings; (iv) performing asset management duties; and (v) performing financial and accounting management, subject to the direction and oversight of the Company's board of directors. Pursuant to the terms of the Management Agreement, the Manager is paid a management fee equal to 1.50% per annum of the Company's stockholders' equity (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears. For purposes of calculating the management fee, "stockholders' equity" means the sum of the net proceeds from any issuances of the Company's equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings, calculated in accordance with GAAP, at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid for repurchases of the Company's shares of common stock, excluding any unrealized gains, losses or other non-cash items, including OTTI charges reportedincluded in other loss on RMBS,MBS, unrealized gain (loss) on RMBSMBS and other securities and non-cash portion of Lossgain (loss) on derivative instruments, that have impacted stockholder's equity as reported in the Company's financial statements prepared in accordance with GAAP, regardless of whether such items are included in other comprehensive income or loss, or in net income, and excluding one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the Manager and the Company's independent directors and after approval by a majority of the Company's independent directors. However, if the Company's stockholders' equity for any given quarter is negative based on the calculation described above, the Manager will not be entitled to receive any management fee for that quarter.

        In addition, the Company may be required to reimburse the Manager for certain expenses as described below.below, and shall reimburse for the compensation paid to the Company's CFO. Expense reimbursements to the Manager are made in cash on a monthly basis following the end of each month. The Company's reimbursement obligation is not subject to any dollar limitation. Because the Manager's personnel perform certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, the Manager may be paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length basis.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 8—9—Related Party Transactions (Continued)

        The Management Agreement may be amended, supplemented or modified by agreement between the Company and the Manager. The initial term of the Management Agreement expires on May 15, 2015 and it is automatically renewed for one-year terms on each anniversary thereafter unless previously terminated as described below. The Company's independent directors will review the Manager's performance and any fees payable to the Manager annually and, following the initial term, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds of the Company's independent directors, based upon: (i) the Manager's unsatisfactory performance that is materially detrimental to the Company; or (ii) the Company's determination that any fees payable to the Manager are not fair, subject to the Manager's right to prevent such termination due to unfair fees by accepting a reduction of management fees agreed to by at least two-thirds (2/3)(²/3) of the Company's independent directors. The Company will provide the Manager 180 days prior notice of any such termination. Unless terminated for cause, the Company will pay the Manager a termination fee equal to three times the average annual management fee earned by the Manager during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.

        The Company may also terminate the Management Agreement at any time, including during the initial term, without the payment of any termination fee, with 30 days prior written notice from the Company's board of directors for cause, which will be determined by a majority of the Company's independent directors, which is defined as: (i) the Manager's continued material breach of any provision of the Management Agreement (including the Manager's failure to comply with the Company's investment guidelines); (ii) the Manager's fraud, misappropriation of funds, or embezzlement against the Company; (iii) the Manager's gross negligence in the performance of its duties under the Management Agreement; (iv) the occurrence of certain events with respect to the bankruptcy or insolvency of the Manager, including an order for relief in an involuntary bankruptcy case or the Manager authorizing or filing a voluntary bankruptcy petition; (v) the Manager is convicted (including a plea of nolo contendere) of a felony; or (vi) the dissolution of the Manager.

        For the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, the Company incurred approximately $7.8 million and approximately $3.1 million in management fees.fees, respectively.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 9—Related Party Transactions (Continued)

        In addition to the management fee, the Company is also responsible for reimbursing the Manager for certain expenses paid by the Manager on behalf of the Company and for certain services provided by the Manager to the Company. For the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, the Company recorded expenses included in general and administrative expense totaling approximately $76 thousand and approximately $23 thousand, respectively related to salary or employee benefits associated with the Company's sole employee paid by the Manager on behalf of the Company. NotwithstandingAs of January 1, 2014, the foregoing, anyaforementioned employee became an employee of the Manager and the Company will reimburse the Manager for such employee's compensation including employee benefits. Any such expenses incurred by the Manager and reimbursed by the Company, including the employee compensation expense discussed above, are typically included in the Company's general and administrative expense on its statementStatement of operations,Operations, or may be reflected on the balance sheetBalance Sheet and associated statement of changes in stockholders' equity, based on the nature of the item. At December 31, 2013 and December 31, 2012, approximately $1.8 million and approximately $1.9 million, respectively for management fees incurred but not yet paid was included in payable to related party on the balance sheet.

        For the period from May 15, 2012 (commencement of operations) through December 31, 2012, the Company declared dividends to the Manager of $120 thousand, of which $57 thousand were payable at December 31, 2012.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)Balance Sheet.

Note 8—Related Party Transactions (Continued)

Offering Costs

        For the period from May 15, 2012 (commencement of operations) through December 31, 2012, the Company was responsible for $1.2 million of offering costs incurred in connection with the Company's IPO of its common stock and concurrent private placements. The Manager agreed to pay for all costs in excess of $1.2 million. In the third quarter, the Company paid the Manager $1.2 million as reimbursement for offering costs previously incurred by the Company with respect to its IPO and paid by the Manager. Underwriting costs of $4.8 million and offering costs of approximately $559 thousand were borne by the Company in connection with its follow-on common stock offering completed in October 2012.

Note 9—10—Share-Based Payments

        In conjunction with the Company's IPO and concurrent private placement, the Company's board of directors approved the Western Asset Mortgage Capital Corporation Equity Plan (the "Equity Plan") and the Western Asset Manager Equity Plan (the "Manager Equity Plan" and collectively the "Equity Incentive Plans").

        On May 15, 2012, the Company granted 51,159 shares of restricted common stock to the Manager under the Manager Equity Plan that is equal to 0.5% of the aggregate number of shares of common stock sold in the IPO and units sold in the concurrent private placement to certain institutional accredited investors. TheseOne-third of these restricted shares vested on May 15, 2013, the first anniversary of the grant date and one-third will vest on each of the first, second and third anniversaries of the grant date.

        On May 15, 2012, the Company granted a total of 4,500 shares (1,500 each) of restricted common stock under the Equity Plan to the Company's three independent directors. These restricted shares will vestvested in full on May 15, 2013, the first anniversary of the grant date.

        On June 25, 2012, the Company granted 10,455 shares of restricted common stock to its chief financial officer under the Equity Plan. One-third of these restricted shares vested on January 1, 2013, one-third will vestvested on January 1, 2014 and the remaining one-third will vest on January 1, 2015.

        On March 1, 2013, the Company granted a total of 150,000 shares of restricted common stock to the Manager under the Manager Equity Plan. One-third of these shares vested on March 1, 2014 and one third will vest on each of the second and third anniversaries of the grant date.

        On March 1, 2013, the Company granted 10,559 shares of restricted common stock to its chief financial officer under the Equity Plan. One-third of these restricted shares vested on January 1, 2014, one-third will vest on January 1, 2015 and the remaining one-third will vest on January 1, 2016.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 10—Share-Based Payments (Continued)

        On June 10, 2013, the Company granted a total of 4,887 (1,629 each) of restricted common stock under the Equity Plan to the Company's three independent directors. These restricted shares will vest in full on the first anniversary of the grant date. Each of the independent directors has elected to defer the shares granted to him under the Company's Director Deferred Fee Plan (the "Director Deferred Fee Plan"). The Director Deferred Fee Plan permits eligible members of the Company's board of directors to defer certain stock awards made under its director compensation programs. The Director Deferred Fee Plan allows directors to defer issuance of their stock awards and therefore defer payment of any tax liability until the deferral is terminated, pursuant to the election form executed each year by each eligible director.

        The Equity Incentive Plans include provisions for grants of restricted common stock and other equity-based awards to the Manager, its employees and employees of its affiliates and to the Company's directors, officers and employees. The Company can issue up to 3.0% of the total number of issued and outstanding shares of its common stock (on a fully diluted basis) at the time of each award (other than any shares previously issued or subject to awards made pursuant to one of ourthe Company's Equity Incentive Plans) under these Equity Incentive Plans. At May 15, 2012, there were 308,335 shares of common stock initially reserved for issuance under the Equity Incentive Plans. Upon the completion of the October 3, 2012 follow-on common stock offering and the stock portion of the Company's dividend declared December 19, 2013, the number of shares of common stock available for issuance under the Equity Incentive Plans increased to 722,335,798,211, inclusive of the 66,114 enumerated above.231,560 shares of restricted stock issued as provided above and the 20,957 shares of restricted stock issued as a result of the stock portion of the dividend declared on December 19, 2013. The Company recognized stock-based compensation expense of approximately $1.1 million and approximately $367 thousand for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012, respectively and hashad unamortized compensation expense of $423 thousand for equity awards and approximately $1.2$3.2 million for liability awards and $360 thousand for equity awards and approximately $811 thousand for liability awards at December 31, 2012.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share2013 and per share data)

Note 9—Share-Based Payments (Continued)December 31, 2012, respectively.

        All restricted common shares granted, other than those whose issuance has been deferred pursuant the Director Deferred Fee Plan, possess all incidents of ownership, including the right to receive dividends and distributions currently, and the right to vote. Dividend equivalent payments otherwise allocable to restricted common shares under the Deferred Compensation Plan are deemed to purchase additional phantom shares of the Company's common stock that are credited to each participant's deferral account. The award agreements include restrictions whereby the restricted shares cannot be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of prior to the lapse of restrictions under the respective award agreement. The restrictions lapse on the unvested restricted shares awarded when vested, subject to the grantee's continuing to provide services to the Company as of the vesting date. Unvested restricted shares and rights to dividends thereon are forfeited upon termination of the grantee.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 10—Share-Based Payments (Continued)

        The following is a summary of restricted common stock vesting dates as of December 31, 2012:2013 and December 31, 2012, including shares whose issuance has been deferred under the Director Deferred Fee Plan:

Vesting Date		Shares Vesting
January     December 31, 2013   December 31, 2012   Vesting Date   Shares Vesting   Shares Vesting   January 2013     —     3,485   May 2013     —     21,553   January 2014     7,685     3,485   March 2014     54,852     —   May 2014     18,707     17,053   June 2014     6,279     —   January 2015     7,685     3,485   March 2015     54,852     —   May 2015     18,707     17,053   January 2016     3,860     —   March 2016     54,852     —               ​ ​ ​ ​ ​ ​ ​ ​     227,479     66,114               ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​                     The following table presents information with respect to the Company's restricted stock for the year ended December 31, 2013 including shares whose issuance has been deferred under the Director Deferred Fee Plan:     Shares of Restricted Stock   Weighted Average Grant Date Fair Value(1)   Outstanding at beginning of period     66,114   $ 19.86   Granted(2)     186,403     20.51   Cancelled/forfeited     —     —               ​ ​ ​ ​ ​ ​ ​ ​ Outstanding at end of year     252,517   $ 20.34               ​ ​ ​ ​ ​ ​ ​ ​ Unvested at end of year     227,479   $ 20.39               ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​             (1) The grant date fair value of restricted stock awards is based on the closing market price of the Company's common stock at the grant date. (2) Included in Granted are restricted stock attributed to the stock portion of the December 19, 2013 dividend on restricted stock of 19,565 shares and restricted stock attributed to dividends on restricted stock under the Director Deferred Fee Plan of 1,392 shares. Table of Contents Western Asset Mortgage Capital Corporation Notes to Financial Statements (Continued) (in thousands—except share and per share data) Note 10—Share-Based Payments (Continued)			3,485
May 2013			21,553
January 2014			3,485
May 2014			17,053
January 2015			3,485
May 2015			17,053
			66,114

        The following table presents information with respect to the Company's restricted stock for the period ended December 31, 2012:

		Shares of Restricted Stock			Weighted Average Grant Date Fair Value(1)				Shares of Restricted Stock			Weighted Average Grant Date Fair Value(1)
Outstanding at beginning of period			—		$	—				—		$	—
Granted			66,114		$	19.86				66,114		$	19.86
Cancelled/forfeited			—		$	—				—		$	—
​								​		​	​		​	​
Outstanding at end of year			66,114		$	19.86				66,114		$	19.86
​								​		​	​		​	​
Unvested at end of year			66,114		$	19.86				66,114		$	19.86
​								​		​	​		​	​
​								​		​	​		​	​

---

(1)

The grant date fair value of restricted stock awards is based on the closing market price of the Company's common stock at the grant date.

Note 10—11—Shareholders Equity

        On May 9, 2012, the Company entered into: (i) a binding underwriting agreement with a group of underwriters to sell 8.0 million shares of the Company's common stock for $20.00 per share for an aggregate offering price of $160.0 million; (ii) unit purchase agreements, pursuant to a private placement, with certain institutional accredited investors to sell 2,231,787 warrant units for $20.00 per unit for an aggregate offering price of approximately $44.6 million; and (iii) an agreement to sell 46,043 shares of the Company's common stock, for $20.00 per share to our Manager's deferred compensation plan in another private placement for an aggregate offering price of approximately $0.9 million.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 10—Shareholders Equity (Continued)

        Each of the aforementioned warrant units consists of one share of the Company's common stock and a warrant to purchase 0.5 of a share of the Company's common stock.stock, subject to adjustment. At the time of issuance, each warrant had an exercise price of $20.50 per share, subject to adjustment upon the occurrence of customary events triggering an anti-dilution adjustment and certain sales of the Company's common stock (see discussion below). In addition, the warrants are subject to certain limitations on exercise. The warrants expire on May 15, 2019. On October 3, 2012, as a result of the follow-on offering the exercise price of the warrants was reduced from $20.50 to $19.44. In addition, on January 28, 2014, the exercise price was further reduced to $17.59, and the warrant shares purchasable increased to 1,232,916 as a result of the stock portion of the December 19, 2013 dividend which was paid on January 28, 2014.

        The net proceeds to the Company from the IPO and two concurrent private placements were approximately $204.4 million, net of offering expenses of $1.2 million for which the Company agreed to be responsible. The Manager agreed to be responsible for all offering expenses in excess of $1.2 million, including the underwriting discount and the placement agent fees in the two private placements (in the aggregate, approximately $7.8 million).




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 11—Shareholders Equity (Continued)

        On September 27, 2012, the Company entered into a binding agreement with a group of underwriters to sell an incremental 12.0 million shares of the Company's common stock, effective as of September 28, 2012, which closed on October 3, 2012. The agreement provided the underwriters with the right to purchase an additional 1.8 million shares (15% of 12.0 million) during the succeeding thirty (30) days. The shares were offered to the market at a price of $22.20 per share and the underwriters exercised their option to purchase the incremental 1.8 million shares on September 28, 2012. Net proceeds to the Company were approximately $301.0 million after subtracting underwriting commissions and offering expenses of approximately $4.8 million. In addition the Company incurred other offering costs of approximately $559 thousand.

        On November 19, 2012, the Board of Directors of the Company approved the repurchase of up to 2.4 million shares of its common stock through December 31, 2013, either in the open market or through privately-negotiated transactions. The repurchase program is expected to be completed during 2013, and does not obligate the Company to acquire any particular amount of common stock. The Company made no share repurchases for the year ended December 31, 2013 nor the period May 15, 2012 (commencement of operations) through December 31, 2012.

        On December 19, 2013, the Company declared a dividend of $2.35 per common share payable in 2012.a combination of cash and stock. For stockholders who elected to receive the entire $2.35 per share dividend in stock, each stockholder received 0.1590 shares in newly issued common stock for each common share that they held as of the dividend record date. For stockholders who elected to receive the dividend in cash, or did not make an election, each stockholder received $0.9159 per share in cash and 0.0970 shares in newly issued common stock for each common share that they held as of the dividend record date. The dividend was paid on January 28, 2014 to shareholders of record as of December 30, 2013. As a result of a portion of the dividend being paid in stock, common shares of 2,548,784 where issued by the Company.




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 11—12—Net Income (loss) per Common Share

        The table below presents basic and diluted net income (loss) per share of common stock using the two-class method for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) through December 31, 2012 (dollars, other than shares and per share amounts, in thousands):

		For the Period from May 15, 2012 (commencement of operations) through December 31, 2012				For the Year Ended December 31, 2013			For the Period from May 15, 2012 (commencement of operations) through December 31, 2012
Numerator:
Net income attributable to common stockholders and participating securities for basic and diluted earnings per share		$	57,277
Net income (loss) attributable to common stockholders and participating securities for basic and diluted earnings per share						$	(27,855	)	$	57,277
Less:
Dividends and undistributed earnings allocated to participating securities			234				961			234
Net income allocable to common stockholders—basic and diluted		$	57,043
​					​		​	​		​	​
Net income (loss) allocable to common stockholders—basic and diluted						$	(28,816	)	$	57,043
​					​		​	​		​	​
​					​		​	​		​	​
Denominator:
Weighted average common shares outstanding for basic earnings per share			15,654,453				24,185,037			15,654,453
​					​		​	​		​	​
​					​		​	​		​	​
Weighted average diluted shares outstanding (stock awards)			9,045				—			9,045
Weighted average diluted shares outstanding (warrants)			55,735				—			55,735
​					​		​	​		​	​
Weighted average common shares outstanding for diluted earnings per share			15,719,233				24,185,037			15,719,233
​					​		​	​		​	​
​					​		​	​		​	​
Basic earnings per common share		$	3.64			$	(1.19	)	$	3.64
​					​		​	​		​	​
​					​		​	​		​	​
Diluted earnings per common share		$	3.63			$	(1.19	)	$	3.63
​					​		​	​		​	​
​					​		​	​		​	​




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Western Asset Mortgage Capital Corporation

Notes        The following potential common shares, which are securities or other contracts that may entitle its holder to Financial Statements (Continued)

(in thousands—except share andobtain common shares, were excluded from diluted earnings per share data)

Note 12—Summarized Quarterly Results (unaudited)

        Revision of Previously Issued Financial Statements for Errors Affecting Certain Items Presented in the Statements of Operations and Statements of Cash Flows

        During the process of preparing its 2012 financial statements,year ended December 31, 2013 as the Company discovered the methodology that was used to accrete interest income and to amortize the cost basis of certain of the Company's residential mortgage backed securities, which was based onhad a third party vendor's system, as well as the presentation with regard to certain items in its Statement of Cash Flows were not in accordance with GAAP. The Company has evaluated the impact of these errors and has concluded that individually and in the aggregate, these errors were not material to any previously issued financial statements. However, the Company has elected to revise the Statements of Operationsnet loss for the period from May 15, 2012 (commencement of operations) through June 30, 2012, the quarter ended September 30, 2012 and for the period from May 15, 2012 (commencement of operations) through September 30, 2012,their inclusion would have been anti-dilutive: 67,257 related to warrants and the Statements of Cash Flows for the period from May 15, 2012 (commencement of operations) through June 30, 2012 and for the period from May 15, 2012 (commencement of operations) through September 30, 2012, when they are next filed in the Company's quarterly financial statements on Form 10-Q for the quarters ending June 30, 2013 and September 30, 201313,434 related to correct these errors. In addition, the Company has reflected the revisions for these errors in the quarterly tables below. The corrections resulted in a reclassification of a portion of the Company's previously reported net interest income to realized and unrealized gains, and certain amounts previously reflected in operating cash flows to investing cash flows (as indicated in the tables below). These revisions had no effect on net income, shareholders' equity, net change in cash, or total assets, of the Company reported for the respective periods.stock awards.




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 12—Summarized Quarterly Results (Continued)

        Statements of Operations for the period from May 15, 2012 (commencement of operations) through June 30, 2012 and for the quarter ended September 30, 2012:

		Period from May 15, 2012 (commencement of operations) through June 30, 2012									Quarter ended September 30, 2012
Amounts in thousands, except share and per share amounts		As Originally Reported			Adjustments			Revised			As Originally Reported			Adjustments			Revised
Net interest income:
Interest income		$	6,850		$	233		$	7,083		$	14,688		$	(1,701	)	$	12,987
Interest expense			725			—			725			1,935			—			1,935
Net interest income			6,125			233			6,358			12,753			(1,701	)		11,052
Other Income (loss):
Interest income on cash balances			—			—			—			2			—			2
Realized gain on sale of residential mortgage-backed securities, net			1,120			37			1,157			6,454			181			6,635
Other loss on residential mortgage-backed securities			(605	)		518			(87	)		(5,545	)		4,193			(1,352	)
Unrealized gain on residential mortgage-backed securities, net			3,925			(942	)		2,983			28,329			(2,104	)		26,225
Loss on derivative instruments, net			(5,313	)		154			(5,159	)		(11,676	)		(569	)		(12,245	)
Other Income, net			(873	)		(233	)		(1,106	)		17,564			1,701			19,265
Operating Expenses:
General and administrative			584			—			584			1,321			—			1,321
Management fee—related party			407			—			407			802			—			802
Total Operating Expenses			991			—			991			2,123			—			2,123
Net income available to Common Stock and Participating Securities		$	4,261			—		$	4,261		$	28,194		$	—		$	28,194
Earnings per share
Net income attributable to common and participating shareholders (basic)		$	0.41		$	—		$	0.41		$	2.73		$	—		$	2.73
Net income attributable to shareholders (diluted)		$	0.41		$	—		$	0.41		$	2.72		$	—		$	2.72




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 12—Summarized Quarterly Results (Continued)

        Statement of Operations for the period from May 15, 2012 (commencement of operations) through September 30, 2012:

Amounts in thousands, except share and per share amounts		As Originally Reported for the period from May 15, 2012 (commencement of operations) through September 30, 2012			Adjustments			Revised for the period from May 15, 2012 (commencement of operations) through September 30, 2012
Net interest income:
Interest income		$	21,538		$	(1,468	)	$	20,070
Interest expense			2,660			—			2,660
Net interest income			18,878			(1,468	)		17,410
Other Income (loss):
Interest income on cash balances			2			—			2
Realized gain on sale of residential mortgage-backed securities, net			7,574			218			7,792
Other loss on residential mortgage-backed securities			(6,150	)		4,711			(1,439	)
Unrealized gain on residential mortgage-backed securities, net			32,254			(3,046	)		29,208
Loss on derivative instruments, net			(16,989	)		(415	)		(17,404	)
Other Income, net			16,691			1,468			18,159
Operating Expenses:
General and administrative			1,905			—			1,905
Management fee—related party			1,209			—			1,209
Total Operating Expenses			3,114			—			3,114
Net income available to Common Stock and Participating Securities		$	32,455			—		$	32,455
Earnings per share
Net income attributable to common and participating shareholders (basic)		$	3.14		$	—		$	3.14
Net income attributable to shareholders (diluted)		$	3.14		$	—		$	3.14




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 12—Summarized Quarterly Results (Continued)

        Statement of Cash Flows (summarized) for the periods from May 15, 2012 (commencement of operations) through June 30, 2012 and from May 15, 2012 (commencement of operations) through September 30, 2012:

		Period from May 15, 2012 (commencement of operations) through June 30, 2012									Period from May 15, 2012 (commencement of operations) through September 30, 2012
Amounts in thousands		As Originally Reported			Adjustments			Revised			As Originally Reported			Adjustments			Revised
Statement of Cash Flows (effect on individual line items)
Net income		$	4,261		$	—		$	4,261		$	32,455		$	—		$	32,455
Adjustments to reconcile net income to net cash provided by operating activities:
Premium amortization and (discount accretion), net			2,198			(631	)		1,567			9,054			(2,824	)		6,230
Unrealized (gain) loss on Residential mortgage-backed securities and other securities, net			(3,925	)		942			(2,983	)		(32,254	)		3,046			(29,208	)
Mark-to-market adjustments on derivative instruments			5,409			(140	)		5,269			17,076			(460	)		16,616
Other loss on Residential mortgage-backed securities			605			(518	)		87			6,150			(4,711	)		1,439
Realized (gain) loss on sale of Residential mortgage-backed securities and other securities, net			(1,120	)		(37	)		(1,157	)		(7,574	)		(218	)		(7,792	)
All other Items			(5,735	)		—			(5,735	)		(3,836	)		—			(3,836	)
Net cash provided by operating activities			1,693			(384	)		1,309			21,071			(5,167	)		15,904
Cash flows from investing activities:
Principal payments and basis recovered on Residential mortgage-backed securities and other securities			8,015			384			8,399			35,619			5,167			40,786
All other items			(1,921,286	)		—			(1,921,286	)		(2,143,351	)		—			(2,143,351	)
Net cash used in investing activities			(1,913,271	)		384			(1,912,887	)		(2,107,732	)		5,167			(2,102,565	)
Cash flows from financing activities:
All items			1,938,358			—			1,938,358			2,106,119			—			2,106,119
Net cash provided by financing activities			1,938,358			—			1,938,358			2,106,119			—			2,106,119
Net increase in cash and cash equivalents			26,780			—			26,780			19,458			—			19,458
Cash and cash equivalents beginning of period			1			—			1			1			—			1
Cash and cash equivalents end of period		$	26,781		$	—		$	26,781		$	19,459		$	—		$	19,459




Table of Contents


Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 12—Summarized Quarterly Results (Continued)

Summarized Quarterly Results

		For the period from May 15, 2012 (commencement of operations) through June 30, 2012, as Revised
					Quarter Ended
					September 30, 2012, as Revised			December 31, 2012
Net Interest Income:
Interest income		$	7,083		$	12,987		$	33,248
Interest expense			725			1,935			5,434
Net Interest Income			6,358			11,052			27,814
Other Income (Loss):
Interest income on cash balances			—			2			9
Realized gain on sale of Residential mortgage-backed securities and other securities, net			1,157			6,635			12,962
Other loss on Residential mortgage-backed securities			(87	)		(1,352	)		(1,767	)
Unrealized gain (loss) on Residential mortgage-backed securities and other securities, net			2,983			26,225			(15,278	)
Gain (loss) on derivative instruments, net			(5,159	)		(12,245	)		4,298
Other Income (loss), net			(1,106	)		19,265			224
Operating Expenses:
General and administrative			584			1,321			1,292
Management fee—related party			407			802			1,924
Total Operating Expenses			991			2,123			3,216
Net income available to Common Stock and participating securities		$	4,261		$	28,194		$	24,822
Earnings per Common Share—Basic		$	0.41		$	2.73		$	1.04
Earnings per Common Share—Diluted		$	0.41		$	2.72		$	1.04
Dividends Declared per Share of Common Stock		$	0.38		$	0.85		$	1.12




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 13—Income Taxes

        Based on the Company's analysis of any potential uncertain income tax positions, the Company concluded that it does not have any uncertain tax positions that meet the recognition or measurement criteria as of December 31, 2012.2013. The Company files U.S. federal and state income tax returns. As of December 31, 2013, tax returns filed by the Company for 2012 are open for examination pursuant to relevant statutes of limitation. In the event that the Company incurs income tax related interest and penalties, the Company's policy is to classify them as a component of provision for income taxes.

Note 14—Contingencies

        From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of business. Management is not aware of any material contingencies at December 31, 2012.2013.




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 15—Summarized Quarterly Results (unaudited)

        The following is a presentation of selected unaudited results of operations:

		Quarter Ended
		March 31, 2013			June 30, 2013, Revised(1)			September 30, 2013			December 31, 2013
Net Interest Income:
Interest income		$	33,750		$	32,742		$	30,654		$	28,182
Interest expense			5,181			4,522			4,273			4,043
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Net Interest Income			28,569			28,220			26,381			24,139
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Other Income (Loss):
Interest income on cash balances and other income			33			12			11			35
Realized gain (loss) on sale of Mortgage-backed securities and other securities, net			(11,660	)		(6,083	)		(46,142	)		(46,827	)
Other loss on Mortgage-backed securities			(2,268	)		(3,533	)		(2,363	)		(3,694	)
Unrealized gain (loss) on Mortgage-backed securities and other securities, net			(54,759	)		(156,286	)		37,528			13,408
Gain (loss) on linked transactions, net			596			3,909			(547	)		179
Gain (loss) on derivative instruments, net			14,840			109,474			(3,809	)		37,042
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Other Income (Loss), net			(53,218	)		(52,507	)		(15,322	)		143
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Operating Expenses:
General and administrative			1,737			1,541			1,484			1,684
Management fee—related party			2,113			1,826			2,032			1,843
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Total Operating Expenses			3,850			3,367			3,516			3,527
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Net income (loss) available to Common Stock and participating securities		$	(28,499	)	$	(27,654	)	$	7,543		$	20,755
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Net income (loss) per Common Share—Basic		$	(1.18	)	$	(1.16	)	$	0.31		$	0.83
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​
Net income (loss) per Common Share—Diluted		$	(1.18	)	$	(1.16	)	$	0.31		$	0.83
​	​	​	​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​	​	​	​

---

(1)

The Company identified an error relating to Basic and Diluted Net Loss per share amounts of $1.14 for the three month period ended June 30, 2013, as previously reported in the June 30, 2013 Form 10-Q. The error understated Basic and Diluted Net Loss per share by $0.02 per share. Management evaluated the impact of the error on the previously reported financial statements and concluded the impact was not material to the financial statements for the three month period ended June 30, 2013 taken as a whole. However, Management has elected to revise the per share amounts to correct for the impact of this error and the revised amounts of $1.16 per share are reflected above.




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Western Asset Mortgage Capital Corporation

Notes to Financial Statements (Continued)

(in thousands—except share and per share data)

Note 15—Summarized Quarterly Results (unaudited) (Continued)

		For the period from May 15, 2012 (commencement of operations) through June 30, 2012, as Revised
					Quarter Ended
					September 30, 2012, as Revised			December 31, 2012
Net Interest Income:
Interest income		$	7,083		$	12,987		$	33,248
Interest expense			725			1,935			5,434
​	​	​	​	​	​	​	​	​	​	​
Net Interest Income			6,358			11,052			27,814
​	​	​	​	​	​	​	​	​	​	​
Other Income (Loss):
Interest income on cash balances			—			2			9
Realized gain on sale of Residential mortgage-backed securities and other securities, net			1,157			6,635			12,962
Other loss on Residential mortgage-backed securities			(87	)		(1,352	)		(1,767	)
Unrealized gain (loss) on Residential mortgage-backed securities and other securities, net			2,983			26,225			(15,278	)
Gain (loss) on derivative instruments, net			(5,159	)		(12,245	)		4,298
​	​	​	​	​	​	​	​	​	​	​
Other Income (loss), net			(1,106	)		19,265			224
​	​	​	​	​	​	​	​	​	​	​
Operating Expenses:
General and administrative			584			1,321			1,292
Management fee—related party			407			802			1,924
​	​	​	​	​	​	​	​	​	​	​
Total Operating Expenses			991			2,123			3,216
​	​	​	​	​	​	​	​	​	​	​
Net income available to Common Stock and participating securities		$	4,261		$	28,194		$	24,822
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​
Earnings per Common Share—Basic		$	0.41		$	2.73		$	1.04
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​
Earnings per Common Share—Diluted		$	0.41		$	2.72		$	1.04
​	​	​	​	​	​	​	​	​	​	​
​	​	​	​	​	​	​	​	​	​	​

Note 16—Subsequent Events

        On March 1, 2013,12, 2014, the Company granted 10,55915,180 shares of restricted common stock to its chief financial officer under the Equity Plan. One-third of these restricted shares vest on January 1, 2014, one-third vest on January 1, 2015Plan and the remaining one-third vest on January 1, 2016.

        On March 1, 2013, the Company granted 150,000200,000 shares of restricted common stock to itsthe Manager under the Manager Equity Plan. One-third of these restrictedthe chief financial officer's shares will vest on MarchJanuary 1, 2014,2015, one-third will vest on January 1, 2016 and the remaining one-third will vest on January 1, 2017. One-third of the Manager's shares will vest on March 1, 2015, one-third will vest on March 1, 2016 and the remaining one-third will vest on March 1, 2016.

        On April 1, 2013, the Company declared a dividend of $0.95 per share payable to shareholders of record as of April 12, 2013 and payable on April 30, 2013.2017.




Table of Contents

ITEM 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.


        None.

ITEM 9A.    Controls and Procedures


(a)

Evaluation of Disclosure Controls and Procedures

        A review and evaluation was performed by the Company's management, including the Company's Chief Executive Officer (the "CEO") and Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of the Company's "disclosureWe maintain disclosure controls and procedures"procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act),Act of 1934, as of December 31, 2012,amended (the "Exchange Act")) that are designed to ensure that information required to be disclosed in the end date ofreports that we file or submit under the period covered by this annual report on Form 10-K. A control system,Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable not absolute, assurance that it will detect or uncover failures withinof achieving the Company to disclose material information otherwisedesired control objectives, and therefore we are required to be set forthapply judgment in evaluating the Company's periodic reports.cost-benefit relationship of possible controls and procedures.

        As described below, management has identified a material weakness inThe Company's Chief Executive Officer and Chief Financial Officer evaluated the Company's internal control over financial reporting. Internal control over financial reporting is an integral componenteffectiveness of the Company'sdesign and operation of our disclosure controls and procedures. Solelyprocedures as a result of this material weakness, the Company's management, including the CEODecember 31, 2013. Based on that evaluation, our Chief Executive Officer and CFO, haveChief Financial Officer concluded that the Company'sour disclosure controls and procedures were not effective as of December 31, 2012.at the reasonable assurance level.

(b)

   Management's Report on Internal Control Overover Financial Reporting

        Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company's principal executiveChief Executive Officer and principal financial officersChief Financial Officer and effected by the Company's board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP,generally accepted accounting principles, and includes those policies and procedures that:

•

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;



•

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and



•

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.




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        Because this annual report on Form 10-K is the first such annual report required to be filed by the Company pursuant to Section 13(d)Management of the Exchange Act, the Company is not required to include herein a report of management's assessment regarding the Company's internal control over financial reporting or an attestation report of the Company's independent registered public accounting firm. As a result, neither such report has been included herein. However, in assessing the Company's disclosure controls and procedures as of December 31, 2012, the Company identified a material weakness in the Company's internal control over financial reporting as described below.

        A "material weakness" is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

        In connection with the preparation of the Company's financial statements included in this annual report on Form 10-K, the Company discovered that the methodology used to accrete interest income and to amortize the cost basis of certain of the Company's investments in RMBS did not comply with GAAP. In order to correct these errors, the Company has reclassified a portionassessed the effectiveness of the Company's net interest income to both realized and unrealized gains.

        Following the identification of the errors described above, the Company determined that a material weakness existed in the Company's internal control over financial reporting as of December 31, 2013. In making its assessment of internal control over financial reporting, management used the criteria described in Internal Control—Integrated Framework (1992 framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission, ("COSO"). Based on this evaluation, management concluded that the Company's internal control over financial reporting was effective as of December 31, 2013 based on criteria in Internal Control—Integrated Framework issued by the COSO.

        This annual report does not include an attestation report of the company's registered public accounting firm due to a temporary exemption transition period established by rules of the Securities and Exchange Commission for emerging growth companies under the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act").

(c)   Remediation of Previously Disclosed Material Weakness

        In conjunction with the filing our Form 10-K for the year ended December 31, 2012, we determined a material weakness in our internal control over financial reporting attributable to management's supervision, review and acceptance procedures with respect to the above-describeda third-party vendor's methodology for and computation of interest income accretion and amortization of the cost basis of certain of the Company's investments in RMBS.

        The Company isresidential mortgage backed securities existed as of that date. Beginning in the processfirst quarter of designing procedures to remediate the material weakness which are expected to include confirming on no less than2013, we implemented a quarterly basis: (i) the accuracyseries of prepayments speeds provided by the Company and utilized by its third party vendor; (ii) the implementation, application and methodology used by its third party vendor for purposes of calculating interest income accretion or amortization of the cost basis for each category of RMBS in the investment portfolio of the Company; (iii) that the aforementioned calculations have been done appropriately by recalculating the applicable interest income accretion or amortization of cost basis for a sample of each category of RMBS; and (iv) review portfolio reports provided by its third party vendorinternal controls over financial reporting in order to identify exceptionsremediate this issue, as described further in our quarterly reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and inconsistencies. The Company believes thatSeptember 30, 2013. We tested the new procedures, whennewly implemented will remediate thecontrols and found them to be effective and have concluded as of December 31, 2013, this material weakness described above. However, the Company cannot provide any assurance that these remediation efforts will be successful or that itshas been remediated.

(d)   Changes in Internal Control over Financial Reporting

        There have been no changes in our internal control over financial reporting will be effective as a result of these efforts.during the three months ended December 31, 2013, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.    Other Information


        None.

ITEM 10.    Directors, Executive Officers and Corporate Governance


        The information regarding the Company's directors, executive officers and certain other matters required by Item 401 of Regulation S-K is incorporated herein by reference to the Company's proxy statement relating to its annual meeting of stockholders to be held on or about June 7, 2013 (the "Proxy Statement"), to be filed with the SEC within 120 days after December 31, 2012.2013.

        The information regarding compliance with Section 16(a) of the Exchange Act required by Item 405 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.2013.

        The information regarding the Company's Code of Business Conduct and Ethics required by Item 406 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.




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        The information regarding certain matters pertaining to the Company's corporate governance required by Item 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.2013.




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ITEM 11.    Executive Compensation.


        The information regarding executive compensation and other compensation related matters required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.2013.

ITEM 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder


        The tables on equity compensation plan information and beneficial ownership of the Company required by Items 201(d) and 403 of Regulation S-K are incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.2013.

ITEM 13.    Certain Relationships and Related Transactions and Director Independence


        The information regarding transactions with related persons, promoters and certain control persons and director independence required by Items 404 and 407(a) of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.2013.

ITEM 14.    Principal Accounting Fees and Services


        The information concerning principal accounting fees and services and the Audit Committee's pre-approval policies and procedures required by Item 9(e) of Schedule 14A is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2012.2013.

        .




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ITEM 15.    Exhibits


        Documents filed as part of this report:

1)

Financial Statements

WESTERN ASSET MORTGAGE CAPITAL CORPORATION
Balance Sheets as of December 31, 20122013 and 20112012
Statement of Operations for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) to December 31, 2012
Statement of Changes in Stockholders' Equity for the period from January 1, 2012 to December 31, 20122013
Statement of Cash Flow for the year ended December 31, 2013 and for the period from May 15, 2012 (commencement of operations) to December 31, 2012
Notes to Financial Statements

        All financial statement schedules have been omitted because the required information is not applicable or deemed not material, or the required information is presented in the financial statements and/or in the notes to financial statements.

2)

Exhibits

        The following exhibits are filed as part of this report.

Exhibit No.			Description
	3.1	*	Amended and restated certificate of incorporation of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 3.1 to Amendment No. 10 Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012
	3.2	*	Amended and restated bylaws of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 3.2 to Amendment No. 10 Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012
	4.1	*	Specimen Common Stock Certificate of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 4.1 to Amendment No. 10 Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012
	10.1	*	Form of Unit Purchase Agreement between Western Asset Mortgage Capital Corporation and certain institutional accredited investors, incorporated by reference to Exhibit 10.1 to Amendment No. 9 Form S-11 (Registration Statement No. 333-159962), filed April 30, 2012.
	10.2	*	Form of Warrant, incorporated by reference to Exhibit 10.2 to Amendment No. 9 Form S-11 (Registration Statement No. 333-159962), filed April 30, 2012.
	10.3	*	Management Agreement, dated May 9, 2012, between Western Asset Mortgage Capital Corporation and Western Asset Management Company, incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q, filed August 14, 2012.
	10.4	*	Registration Rights Agreement, dated May 15, 2012, among Western Asset Mortgage Capital Corporation, Western Asset Management Company and certain individual holders named therein, incorporated by reference to Exhibit 10.5 to the Quarterly Report on Form 10-Q, filed August 14, 2012.




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Exhibit No.			Description
	10.5	*	Western Asset Mortgage Capital Corporation Equity Plan, incorporated by reference to Exhibit 10.5 to Amendment No. 9 Form S-11 (Registration Statement No. 333-159962), filed April 30, 2012.
	10.6	*	Western Asset Mortgage Capital Corporation Manager Equity Plan, incorporated by reference to Exhibit 10.6 to Amendment No. 9 Form S-11 (Registration Statement No. 333-159962), filed April 30, 2012.
	10.7	*	Form of Indemnification Agreement between Western Asset Mortgage Capital Corporation and a director, incorporated by reference to Exhibit 10.7 to Amendment No. 9 Form S-11 (Registration Statement No. 333-159962), filed April 30, 2012.
	10.8	*	Restricted Stock Award Agreement, dated May 15, 2012, for Western Asset Management Company, incorporated by reference to Exhibit 10.9 to the Quarterly Report on Form 10-Q, filed August 14, 2012.
	10.9	*	Form of Restricted Stock Award Agreement for independent directors, incorporated by reference to Exhibit 10.2 to the Form S-8 dated May 15, 2012 (File No. 1-35543).
	23.1		Consent of Independent Registered Public Accounting Firm.
	31.1		Rule 13a-14(a) / 15d-14(a) Certification of Chief Executive Officer.
	31.2		Rule 13a-14(a) / 15d-14(a) Certification of Chief Financial Officer.
	32.1		Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer
	101.INS	**	XBRL Instance Document
	101.SCH	**	XBRL Taxonomy Extension Schema Document
	101.CAL	**	XBRL Taxonomy Extension Calculation Linkbase Document
	101.DEF	**	XBRL Taxonomy Extension Definition Linkbase Document
	101.LAB	**	XBRL Taxonomy Extension Label Linkbase Document
	101.PRE	**	XBRL Taxonomy Extension Presentation Linkbase Document

---

*

Fully or partly previously filed.



**

These interactive data files are furnished and not deemed filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act, and are not deemed filed for purposes of Section 18 of the Exchange Act, and otherwise are not subject to liability under those sections.




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SIGNATURES


        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		WESTERN ASSET MORTGAGE CAPITAL CORPORATION
		By:		/s/ GAVIN L. JAMES Gavin L. James President, Chief Executive Officer and Director
		April 8, 2013 March 17, 2014

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

		By:		/s/ GAVIN L. JAMES Gavin L. James President, Chief Executive Officer and Director (Principal Executive Officer)
		April 8, 2013March 17, 2014
		By:		/s/ STEVEN M. SHERWYN Steven M. Sherwyn Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)
		April 8, 2013March 17, 2014
		By:		/s/ JAMES W. HIRSCHMANN III James W. Hirschmann III Director
		April 8, 2013March 17, 2014
		By:		/s/ EDWARD D. FOX JR. Edward D. Fox Jr. Director
		April 8, 2013 March 17, 2014




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		By:		/s/ RICHARD ROLL Richard Roll Director
		April 8, 2013March 17, 2014
		By:		/s/ M. CHRISTIAN MITCHELL M. Christian Mitchell Director
		April 8, 2013 March 17, 2014