Hatteras Financial (HTS) 10-Q 2010 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended June 30, 2010

OR

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

For the transition period from            to            .

Commission file number 001-34030

HATTERAS FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Maryland	26-1141886
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
110 Oakwood Drive, Suite 340 Winston Salem, North Carolina	27103
(Address of principal executive offices)	(Zip Code)

(336) 760-9347

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every

Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x     No  ¨

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

Large accelerated filer	x	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	¨

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

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

Class	Outstanding at July 28, 2010
Common Stock ($0.001 par value)	37,477,070

TABLE OF CONTENTS

		Page
PART I	Financial Information
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	35
Item 4.	Controls and Procedures	38
PART II	Other Information	39
Item 1.	Legal Proceedings	39
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	[Removed and Reserved.]	39
Item 5.	Other Information	39
Item 6.	Exhibits	39
	Signatures	40

Hatteras Financial Corp.

Balance Sheets

(In thousands, except per share amounts)	(Unaudited)
	June 30, 2010		December 31, 2009
Assets
Mortgage-backed securities, at fair value (including pledged assets of $6,304,729 and $6,660,330 at June 30, 2010 and December 31, 2009, respectively)	$	6,791,701	$	6,992,771
Cash and cash equivalents		89,955		225,828
Restricted cash		95,014		61,361
Unsettled purchased mortgage-backed securities, at fair value		46,865		46,216
Accrued interest receivable		31,505		35,560
Principal payments receivable		41,809		35,917
Debt security, held to maturity, at cost		10,000		10,000
Interest rate hedge asset		—		7,851
Other assets		13,614		898
Total assets	$	7,120,463	$	7,416,402
Liabilities and shareholders’ equity
Repurchase agreements	$	5,982,998	$	6,346,518
Payable for unsettled securities		46,461		46,453
Accrued interest payable		2,494		2,969
Interest rate hedge liability		80,588		43,446
Dividend payable		41,127		43,440
Accounts payable and other liabilities		1,176		1,863
Total liabilities		6,154,844		6,484,689
Shareholders’ equity:
Preferred stock, $.001 par value, 10,000 shares authorized, none outstanding at June 30, 2010 and December 31, 2009		—		—
Common stock, $.001 par value, 100,000 shares authorized, 37,388 and 36,200 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively		37		36
Additional paid-in capital		803,894		770,232
Retained earnings		4,376		8,722
Accumulated other comprehensive income		157,312		152,723
Total shareholders’ equity		965,619		931,713
Total liabilities and shareholders’ equity	$	7,120,463	$	7,416,402

See accompanying notes.

3

Hatteras Financial Corp.

Statements of Income

(Unaudited)

(In thousands, except per share amounts)	Three months Ended June 30, 2010		Three months Ended June 30, 2009		Six months Ended June 30, 2010		Six months Ended June 30, 2009
Interest income:
Interest income on mortgage-backed securities	$	63,441	$	69,736	$	132,382	$	137,391
Interest income on short-term cash investments		298		70		575		250
Interest income		63,739		69,806		132,957		137,641
Interest expense		23,677		23,301		47,117		49,297
Net interest income		40,062		46,505		85,840		88,344
Other income:
Gain on sale of mortgage-backed securities		—		—		1,044		—
Operating expenses:
Management fee		2,196		2,166		4,379		4,327
Share based compensation		347		321		690		632
General and administrative		707		522		1,269		1,080
Total operating expenses		3,250		3,009		6,338		6,039
Net income	$	36,812	$	43,496	$	80,546	$	82,305
Earnings per share - common stock, basic	$	1.01	$	1.20	$	2.21	$	2.27
Earnings per share - common stock, diluted	$	1.01	$	1.20	$	2.21	$	2.27
Dividends per share	$	1.10	$	1.10	$	2.30	$	2.15
Weighted average shares outstanding		36,609		36,193		36,427		36,192

See accompanying notes.

4

Hatteras Financial Corp.

Statement of Changes in Shareholders’ Equity

For the six months ended June 30, 2010

(Unaudited)

(Dollars in thousands)	Common Stock			Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total
	Shares	Amount
Balance at December 31, 2009	36,200	$	36	$	770,232	$	8,722		$	152,723		$	931,713
Issuance of restricted stock	7		—		—		—			—			—
Issuance of common stock	1,181		1		32,972		—			—			32,973
Share based compensation expense	—		—		690		—			—			690
Dividends declared on common stock	—		—		—		(84,892	)		—			(84,892	)
Comprehensive income:
Net income	—		—		—		80,546			—			80,546
Other comprehensive income:
Net unrealized gain on securities available for sale	—		—		—		—			40,794			40,794
Net unrealized loss on derivative instruments	—		—		—		—			(36,205	)		(36,205	)
Comprehensive income													85,135
Balance at June 30, 2010	37,388	$	37	$	803,894	$	4,376		$	157,312		$	965,619

See accompanying notes.

5

Hatteras Financial Corp.

Statements of Cash Flows

(Unaudited)

(Dollars in thousands)	For the six months ended June 30, 2010			For the six months ended June 30, 2009
Operating activities
Net income	$	80,546		$	82,305
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premium related to mortgage-backed securities		20,534			7,778
Amortization related to interest rate swap agreements		110			78
Share based compensation expense		690			632
Hedge ineffectiveness		261			(179	)
Gain on sale of mortgage-backed securities		(1,044	)		—
Changes in operating assets and liabilities:
Decrease (increase) in accrued interest receivable		4,055			(5,949	)
Increase in other assets		(4,299	)		(535	)
Decrease in accrued interest payable		(475	)		(5,774	)
Decrease in accounts payable and other liabilities		(687	)		(247	)
Net cash provided by operating activities		99,691			78,109
Investing activities
Purchases of mortgage-backed securities		(1,137,688	)		(1,525,501	)
Principal repayments of mortgage-backed securities		1,323,000			475,692
Sale of mortgage-backed securities		30,529			—
Net cash provided by (used in) investing activities		215,841			(1,049,809	)
Financing activities
Issuance of common stock, net of cost of issuance		32,974			(132	)
Cash dividends paid		(87,206	)		(64,778	)
(Increase) decrease in restricted cash		(33,653	)		8,632
Proceeds from repurchase agreements		35,332,262			29,687,560
Principal repayments on repurchase agreements		(35,695,782	)		(28,710,141	)
Net cash (used in) provided by financing activities		(451,405	)		921,141
Net decrease in cash and cash equivalents		(135,873	)		(50,559	)
Cash and cash equivalents, beginning of period		225,828			143,717
Cash and cash equivalents, end of period	$	89,955		$	93,158
Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	47,593		$	55,071
Supplemental schedule of non-cash financing activities
Obligation to brokers incurred for purchase of mortgage-backed securities	$	850,634		$	477,770

See accompanying notes.

6

Hatteras Financial Corp.

Notes to Financial Statements

June 30, 2010

(Dollars in thousands except per share amounts)

1. Organization and Business Description

Hatteras Financial Corp. (the “Company”) was incorporated in Maryland on September 19, 2007, and commenced its planned business activities on November 5, 2007, the date of the initial closing of a private issuance of common stock. The Company was formed to invest in residential mortgage-backed securities (“MBS”), issued or guaranteed by the U.S. Government or U.S. Government sponsored agencies such as Ginnie Mae, Fannie Mae and Freddie Mac (“agency MBS”). The Company is externally managed by Atlantic Capital Advisors, LLC.

The Company has elected to be taxed as a real estate investment trust (“REIT”). As a result, the Company does not pay federal income taxes on taxable income distributed to shareholders if certain REIT qualification tests are met. It is the Company’s policy to distribute 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Internal Revenue Code of 1986, as amended (the “Code”), which may extend into the subsequent taxable year.

2. Summary of Significant Accounting Policies

Basis of Presentation and Use of Estimates

The accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2010. These unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2009. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates affecting the accompanying financial statements include the valuation of mortgage-backed securities (“MBS”) and derivative instruments.

Since inception, the Company had limited its exposure to credit losses on its portfolio of securities by purchasing MBS guaranteed by Fannie Mae and Freddie Mac. The portfolio is diversified to avoid undue exposure to loan originator, geographic and other types of concentration. The Company manages the risk of prepayments of the underlying mortgages by creating a diversified portfolio with a variety of prepayment characteristics. See footnote 4 for additional information on MBS.

The Company is engaged in various trading and brokerage activities including derivative interest rate swap agreements in which counterparties primarily include broker-dealers, banks, and other financial institutions. In the event counterparties do not fulfill their obligations, the Company may be exposed to risk of loss. The risk of default depends on the creditworthiness of the counterparty and/or issuer of the instrument. It is the Company’s policy to review, as necessary, the credit standing for each counterparty. See Note 7 for additional information on interest rate swap agreements.

7

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

Financial Instruments

The Company considers its cash and cash equivalents, restricted cash, MBS (settled and unsettled), forward purchase commitments, debt security held to maturity, accrued interest receivable, accounts payable, derivative instruments, repurchase agreements and accrued interest payable to meet the definition of financial instruments. The carrying amount of cash and cash equivalents, restricted cash, accrued interest receivable and accounts payable approximated their fair value due to the short maturities of these instruments. See Note 4 for discussion of the fair value of MBS securities and forward purchase commitments. See Note 5 for discussion of the fair value of the held to maturity debt security. See Note 7 for discussion of the fair value of derivatives. The carrying amount of the repurchase agreements and accrued interest payable is deemed to approximate fair value since the lines are based upon a variable rate of interest.

Mortgage-Backed Securities

The Company invests in Agency MBS representing interests in or obligations backed by pools of single-family adjustable-rate mortgage loans. Guidance under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic on Investments requires the Company to classify its investments as either trading, available-for-sale or held-to-maturity securities. Management determines the appropriate classifications of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. The Company currently classifies all of its MBS as available-for-sale. All assets that are classified as available-for-sale are carried at fair value and unrealized gains and losses are included in other comprehensive income or loss as a component of shareholders’ equity. The estimated fair values of MBS are determined by management by obtaining valuations for its MBS from three separate and independent sources and averaging these valuations. Security purchase and sale transactions are recorded on the trade date. Gains or losses realized from the sale of securities are included in income and are determined using the specific identification method. Firm purchase commitments to acquire “when issued” or to-be-announced securities (“TBA” securities) are recorded at fair value in accordance with ASC Topic 815,Derivatives and Hedging.The fair value of these purchase commitments is included in other assets or liabilities in the accompanying balance sheets.

The Company assesses its investment securities 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 uses a two step evaluation process. First, the Company determines whether it has made any decision to sell a security that is in an unrealized loss position, or, if not the Company determines whether it is more likely than not that the Company will be required to sell the security prior to recovering its amortized cost basis. If the answer to either of these questions is “yes” then the security is considered other-than-temporarily impaired. There were no such impairment losses recognized during the periods presented.

Interest Income

Interest income is earned and recognized based on the outstanding principal amount of the investment securities and their contractual terms. Premiums and discounts associated with the purchase of the investment securities are amortized or accreted into interest income over the actual lives of the securities using the effective interest method.

Income Taxes

The Company has elected to be taxed as a REIT under the Code. The Company will generally not be subject to Federal income tax to the extent that it distributes 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Code and as long as it satisfies the ongoing REIT requirements including meeting certain asset, income and stock ownership tests.

8

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

Share-Based Compensation

Share-based compensation is accounted for under the guidance included in the ASC Topic on Stock Compensation. For share and share-based awards issued to employees, a compensation charge is recorded in earnings based on the fair value of the award. For transactions with non-employees in which services are performed in exchange for the Company’s common stock or other equity instruments, the transactions are recorded on the basis of the fair value of the service received or the fair value of the equity instruments issued, whichever is more readily measurable at the date of issuance. The Company’s share-based compensation transactions resulted in compensation expense of $347 and $321 for the three months ended June 30, 2010 and 2009, respectively. The Company’s share-based compensation transactions resulted in compensation expense of $690 and $632 for the six months ended June 30, 2010 and 2009, respectively.

Earnings Per Common Share (EPS)

Basic EPS is computed by dividing net income available to holders of common stock by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed by dividing net income available to holders of common stock by the weighted average shares of common stock and common equivalent shares outstanding during the period. For the diluted EPS calculation, common equivalent shares outstanding includes the weighted average number of shares of common stock outstanding adjusted for the effect of dilutive unexercised stock options.

Recent Accounting Pronouncements

In January 2010, the FASB issued an Accounting Standards Update (“ASU”) onImproving Disclosures About Fair Value Measurements, which clarifies certain existing disclosure requirements and requires additional disclosures for recurring and nonrecurring fair value measurements. These additional disclosures include amounts and reasons for significant transfers between Level 1 and Level 2 of the fair value hierarchy; significant transfers in and out of Level 3 of the fair value hierarchy; and information about purchases, sales, issuances and settlements on a gross basis in the reconciliation of recurring Level 3 measurements. The requirements of this standard are effective for periods beginning after December 15, 2009, with the exception of the requirement of information about purchases, sales, issuances and settlements of Level 3 measurements, which becomes effective for periods ending after December 15, 2010. The Company adopted the guidance related to Level 1 and Level 2 disclosures and the adoption did not have a material effect on the Company’s financial statements.

3. Financial Instruments

The Company’s valuation techniques of financial instruments are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. The ASC Topic on Fair Value Measurements classifies these inputs into the following hierarchy:

Level 1 Inputs – Quoted prices for identical instruments in active markets.

Level 2 Inputs – Quoted prices for similar instruments 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.

Level 3 Inputs – Instruments with primarily unobservable value drivers.

9

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

The fair values of the Company’s MBS and interest rate hedges based on the level of inputs are summarized below:

	June 30, 2010
	Fair Value Measurements Using						Total at
	Level 1		Level 2		Level 3		Fair Value
Assets
Mortgage backed securities	$	—	$	6,791,701	$	—	$	6,791,701
Unsettled purchased mortgage backed securities		—		46,865		—		46,865
Forward purchase commitments				8,528				8,528
Total	$	—	$	6,847,094	$	—	$	6,847,094
Liabilities
Interest rate hedges	$	—	$	80,588	$	—	$	80,588
Total	$	—	$	80,588	$	—	$	80,588

The carrying values and approximate fair values of all financial instruments as of June 30, 2010 and December 31, 2009 were as follows:

	June 30, 2010				December 31, 2009
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Mortgage backed securities	$	6,791,701	$	6,791,701	$	6,992,771	$	6,992,771
Unsettled purchased mortgage backed securities		46,865		46,865		46,216		46,216
Cash and cash equivalents		89,955		89,955		225,828		225,828
Restricted cash		95,014		95,014		61,361		61,361
Accrued interest receivable		31,505		31,505		35,560		35,560
Debt security		10,000		10,000		10,000		10,000
Forward purchase commitments		8,528		8,528		—		—
Interest rate hedge asset		—		—		7,851		7,851
Liabilities
Repurchase agreements	$	5,982,998	$	5,982,998	$	6,346,518	$	6,346,518
Payable for unsettled securities		46,461		46,461		46,453		46,453
Accrued interest payable		2,494		2,494		2,969		2,969
Interest rate hedge liability		80,588		80,588		43,446		43,446

4. Mortgage-Backed Securities

All of the Company’s MBS were classified as available-for-sale and, as such, are reported at their estimated fair value. The estimated fair values of MBS are determined by management from three separate and independent sources and averaging these valuations. If the fair value of a security is not available from a dealer or third-party pricing service, or such data appear unreliable, the Company may estimate the fair value of the security using a variety of methods including, but not limited to, other pricing services, repurchase agreement pricing, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable

10

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

market factors. At June 30, 2010, all of the Company’s MBS values were based on third-party sources. The Company’s MBS portfolio consists solely of agency MBS, which are backed by a U.S. Government agency or a U.S. Government sponsored entity. The following table presents certain information about the Company’s MBS at June 30, 2010.

	MBS Amortized Cost		Gross Unrealized Gain		Estimated Fair Value
Agency MBS
Fannie Mae Certificates	$	4,664,714	$	159,992	$	4,824,706
Freddie Mac Certificates		1,898,131		68,864		1,966,995
Total MBS	$	6,562,845	$	228,856	$	6,791,701

The following table presents certain information about the Company’s MBS at December 31, 2009.

	MBS Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency MBS
Fannie Mae Certificates	$	4,850,341	$	(1,290	)	$	127,739	$	4,976,790
Freddie Mac Certificates		1,953,727		—			62,254		2,015,981
Total MBS	$	6,804,068	$	(1,290	)	$	189,993	$	6,992,771

The components of the carrying value of available-for-sale MBS at June 30, 2010 and December 31, 2009 are presented below.

	June 30, 2010			December 31, 2009
Principal balance	$	6,460,721		$	6,702,302
Unamortized premium		102,141			101,789
Unamortized discount		(17	)		(23	)
Gross unrealized gains		228,856			189,993
Gross unrealized losses		—			(1,290	)
Carrying value/estimated fair value	$	6,791,701		$	6,992,771

The Company monitors the performance and market value of its MBS portfolio on an ongoing basis. At June 30, 2010 the Company did not have any MBS securities in a loss position. At December 31, 2009, the Company had the following securities in a loss position:

	Less than 12 months as of December 31, 2009
	Fair Market Value		Unrealized Loss
Fannie Mae Certificates	$	313,882	$	(1,290	)
Freddie Mac Certificates		—		—
Total temporarily impaired securities	$	313,882	$	(1,290	)

11

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

The Company did not make the decision to sell these securities as of December 31, 2009, nor was it deemed more likely than not the Company would be required to sell these securities before recovery of their amortized cost basis.

The following table presents components of interest income on the Company’s MBS portfolio for the three and six months ended June 30, 2010 and 2009, respectively:

	Three Months Ended						Six Months Ended
	June 30, 2010			June 30, 2009			June 30, 2010			June 30, 2009
Coupon interest on MBS	$	74,761		$	74,556		$	152,915		$	145,169
Net premium amortization		(11,320	)		(4,820	)		(20,533	)		(7,778	)
Interest income on MBS, net	$	63,441		$	69,736		$	132,382		$	137,391

The contractual maturity of the Company’s MBS ranges from 20 to 30 years. Because of prepayments on the underlying mortgage loans, the actual weighted-average maturity is expected to be less than the stated maturity. The following table presents certain information about the Company’s MBS that will reprice or amortize based on contractual terms, which do not consider prepayment assumptions at June 30, 2010 and December 31, 2009:

	June 30, 2010						December 31, 2009
	Fair Value		% of Total		Weighted Average Coupon		Fair Value		% of Total		Weighted Average Coupon
Months to Coupon Reset or Contractual Payment
0 - 36 Months	$	2,828,926	41.7	%	4.99	%	$	1,893,993	27.1	%	5.23	%
37 - 60 Months		3,533,326	52.0	%	4.28	%		3,717,454	53.2	%	4.63	%
61 - 84 Months		389,235	5.7	%	4.15	%		1,367,106	19.6	%	5.00	%
85 - 120 Months		40,214	0.6	%	4.05	%		14,219	0.2	%	4.38	%
Total MBS	$	6,791,701	100.0	%	4.56	%	$	6,992,771	100.0	%	4.86	%

The Company may from time to time enter into forward commitments to purchase TBA securities. The fair value of these forward purchase commitments are generally recorded as derivative assets or liabilities until the time of settlement. Forward commitments to purchase TBA securities are valued using the same method to value MBS described above. The following table shows the Company’s commitment to acquire TBA securities at June 30, 2010.

Face	Cost		Fair Market Value		Due to Brokers (1)
$785,000	$	804,173	$	812,701	$	804,173

(1) Amounts due to brokers are usually settled within 30-90 days after period end.

The amounts shown above are in addition to the unsettled purchased mortgage-backed securities shown on the balance sheet.

5. Debt Security, Held to Maturity

During 2009, the Company acquired a $10,000 debt security from a repurchase lending counterparty. The security is AAA-rated by Standard and Poors, Inc. and matures December 15, 2010. It bears interest at the rate of 10% per

12

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

annum, payable monthly, and is callable by the issuer at par. The Company estimates the fair value of this note to approximate amortized cost based on the prices of other AAA rated securities with similar maturities, considering the coupon, the lack of marketability and the non-public nature of the issuer.

6. Repurchase Agreements

At June 30, 2010 and December 31, 2009, the Company had repurchase agreements in place in the amount of $5,982,998 and $6,346,518, respectively, to finance MBS purchases. At June 30, 2010 and December 31, 2009, the average interest rate on these borrowings was 0.42% and 0.41%, respectively. The Company’s repurchase agreements are collateralized by the Company’s MBS and typically bear interest at rates that are similar to LIBOR. At June 30, 2010 and December 31, 2009, the Company had repurchase agreements outstanding with 20 and 18 counterparties, respectively, with a weighted average contractual maturity of 1.2 months and 1.6 months, respectively. The following table presents the contractual repricing information regarding the Company’s repurchase agreements:

	June 30, 2010				December 31, 2009
	Balance		Weighted Average Contractual Rate		Balance		Weighted Average Contractual Rate
Within 30 days	$	5,682,998	0.28	%	$	5,946,518	0.24	%
30 days to 3 months		—	—			—	—
3 months to 36 months		300,000	3.06	%		400,000	3.01	%
	$	5,982,998	0.42	%	$	6,346,518	0.41	%

7. Derivatives - Interest Rate Swap Agreements

Risk Management Objective of Using Derivatives

The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding. The Company’s primary source of debt funding is repurchase agreements. Since the interest rate on repurchase agreements change on a monthly basis, the Company is exposed to constantly changing interest rates, and the cash flows associated with these rates. To minimize the effect of changes in these interest rates, the Company enters into interest rate swap agreements and enters into forward commitments to purchase TBA securities which help to manage the volatility in the interest rate exposures and their related cash flows.

Cash Flow Hedges of Interest Rate Risk

The Company finances its activities primarily through repurchase agreements, which are generally settled on a short-term basis, usually from one to three months. At each settlement date, the Company refinances each repurchase agreement at the market interest rate at that time. Since the interest rates on its repurchase agreements change on a monthly basis, the Company is constantly exposed to changing interest rates. The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company currently uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The effect of these hedges is to synthetically lock up interest rates on a portion of the Company’s outstanding debt for the terms of the swaps.

13

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

For qualifying derivatives under cash flow hedge accounting, effective hedge gains or losses are initially recorded in accumulated other comprehensive income (loss) and subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended June 30, 2010 and 2009, these effective hedge gain (loss) totaled ($49,125) and $11,294, respectively. During the six months ended June 30, 2010 and 2009, these effective hedge losses totaled ($78,559) and ($324), respectively. Ineffective gains (losses) are recorded on a current basis in earnings and for the three months ended June 30, 2010 and 2009, the Company recorded ($48) and $203, respectively. For the six months ending June 30, 2010 and 2009 the Company recorded ($261) and $179, respectively, of hedge ineffectiveness gains (losses) in earnings. The hedge ineffectiveness is attributable primarily to differences in the reset dates on the Company’s swaps versus the refinancing dates of its repurchase agreements.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest is accrued and paid on the Company’s repurchase agreements. During the next 12 months, the Company estimates that an additional $54,714 will be reclassified as an increase to interest expense.

The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over an average period of 25 months.

Maturity	Notional Amount		Weighted Average Remaining Term in Months	Fixed Interest Rate in Contract
12 months or less	$	1,000,000	7	3.34	%
Over 12 months to 24 months		300,000	16	3.45	%
Over 24 months to 36 months		700,000	30	1.86	%
Over 36 months to 48 months		900,000	43	2.23	%
Over 48 months to 60 months		500,000	53	2.36	%
Total	$	3,400,000	29	2.61	%

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheet as of June 30, 2010 and December 31, 2009.

	Asset Derivatives						Liability Derivatives
	As of June 30, 2010			As of December 31, 2009			As of June 30, 2010			As of December 31, 2009
	Balance Sheet	Fair Value		Balance Sheet	Fair Value		Balance Sheet	Fair Value		Balance Sheet	Fair Value
Interest rate hedge	Interest rate	$	—	Interest rate	$	7,851	Interest rate	$	80,588	Interest rate	$	43,446
	hedge asset			hedge asset			hedge liability			hedge liability
Forward purchase commitment	Other	$	8,528	—	$	—	—	$	—	—	$	—
	assets

14

Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

The table below presents the effect of the Company’s derivative financial instruments on the income statement for the three months ended June 30, 2010.

Derivative type for cash flow hedge	Amount of loss  recognized in OCI on derivative (effective portion)		Location of loss reclassified  from accumulated OCI into income (effective portion)	Amount of  loss reclassified from accumulated OCI into income (effective portion)		Location of loss recognized in income on derivative (ineffective portion)	Amount of loss recognized  in income on derivative (ineffective portion)
Interest Rate	$	49,125	Interest Expense	$	16,959	Interest Expense	$	48

The table below presents the effect of the Company’s derivative financial instruments on the income statement for the three months ended June 30, 2009.

Derivative type for cash flow hedge	Amount of gain  recognized in OCI on derivative (effective portion)		Location of loss reclassified  from accumulated OCI into income (effective portion)	Amount of  loss reclassified from accumulated OCI  into income (effective portion)		Location of gain recognized in income on derivative (ineffective portion)	Amount of gain recognized  in income on derivative (ineffective portion)
Interest Rate	$	11,294	Interest Expense	$	12,439	Interest Expense	$	203

The table below presents the effect of the Company’s derivative financial instruments on the income statement for the six months ended June 30, 2010.

Derivative type for cash flow hedge	Amount of loss  recognized in OCI on derivative (effective portion)		Location of loss reclassified  from accumulated OCI into income (effective portion)	Amount of  loss reclassified from accumulated OCI  into income (effective portion)		Location of gain recognized in income on derivative (ineffective portion)	Amount of gain recognized  in income on derivative (ineffective portion)
Interest Rate	$	78,559	Interest Expense	$	33,826	Interest Expense	$	261

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Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

The table below presents the effect of the Company’s derivative financial instruments on the income statement for the six months ended June 30, 2009.

Derivative type for cash flow hedge	Amount of loss  recognized in OCI on derivative (effective portion)		Location of loss reclassified  from accumulated OCI into income (effective portion)	Amount of  loss reclassified from accumulated OCI  into income (effective portion)		Location of gain recognized in income on derivative (ineffective portion)	Amount of gain recognized  in income on derivative (ineffective portion)
Interest Rate	$	324	Interest Expense	$	23,047	Interest Expense	$	179

The following table presents the impact of the Company’s interest rate swap agreements on the Company’s accumulated other comprehensive income for the six months ended June 30, 2010 and the year ended December 31, 2009, respectively.

	June 30, 2010			December 31,2009
Beginning balance	$	(35,742	)	$	(62,496	)
Unrealized gain (loss) on interest rate swaps		(78,559	)		(26,256	)
Reclassification of net losses included in income statement		33,826			53,010
Ending balance	$	(80,475	)	$	(35,742	)

During the six months ended June 30, 2010, the Company entered into forward commitments to purchase TBA agency securities that were accounted for as derivatives. These forward contracts were designated as all-in-one cash flow hedges pursuant to ASC Topic 815. The fair value of the forward commitment of $8,528 is reported in other assets, with a corresponding unrealized gain recognized in other comprehensive income. On the date of physical settlement, unrealized gains or losses will be reclassified to OCI for available-for-sale securities.

Credit-risk-related Contingent Features

The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender then the Company could also be declared in default on its derivative obligations with those counterparties.

The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company’s U.S. GAAP shareholders’ equity declines by a specified percentage over a specified time period, or if the Company fails to maintain a minimum shareholders’ equity threshold, then the Company could be declared in default on its derivative obligations. The Company has an agreement with one of its derivative counterparties that contain a provision where if the Company exceeds a leverage ratio of 12 to 1 then the Company could be declared in default on its derivative obligations with that counterparty.

As of June 30, 2010, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $80,588. The Company has collateral posting requirements with each of its counterparties and all interest rate swap agreements were fully collateralized as of June 30, 2010. At June 30, 2010 the Company was in compliance with these requirements.

8. Capital Stock

On October 9, 2009, the Company entered into a Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co. (“Cantor”) to create a controlled equity offering program (the “CEO Program”). Under the terms of the Sales Agreement, the Company may offer and sell up to 5,000,000 shares of its common stock from time to time through Cantor, acting as agent and/or principal. Sales of the shares of common stock, if any, may be made in private

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Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

transactions, negotiated transactions or any method permitted by law deemed to an “at the market” offering as defined in Rule 415 under the Securities Act of 1933, as amended, including sales made directly on the New York Stock Exchange (“NYSE”) or to or though a market maker other than on an exchange. For the three months ended June 30, 2010, the Company issued 916 shares of common stock in at-the-market transactions, raising net proceeds to the Company, after sales commissions and fees, of $26,095. For the six months ended June 30, 2010, the Company issued 1,181 shares of common stock in at-the-market transactions, raising net proceeds to the Company, after sales commissions and fees, of $32,973. The Company incurs legal, accounting and other fees associated with the issuance of shares under this program. The total amount charged to additional paid in capital in connection with the issuance of these shares was $508 and $817, respectively, for the three and six months ended June 30, 2010. The shares of common stock issuable pursuant to the CEO Program are registered with the SEC on the Company’s Registration Statement on Form S-3 (No. 333-159145), which became effective upon filing on October 9, 2009.

9. Earnings per Share

	For the three months ended				For the six months ended
	June 30, 2010		June 30, 2009		June 30, 2010		June 30, 2009
Basic earnings per share:
Net income	$	36,812	$	43,496	$	80,546	$	82,305
Weighted average shares		36,609		36,193		36,427		36,192
Basic earnings per share	$	1.01	$	1.20	$	2.21	$	2.27
Diluted earnings per share:
Net income	$	36,812	$	43,496	$	80,546	$	82,305
Weighted average shares		36,609		36,193		36,427		36,192
Potential dilutive shares from exercise of stock options		21		18		20		18
Diluted weighted average shares		36,630		36,211		36,447		36,210
Diluted earnings per share	$	1.01	$	1.20	$	2.21	$	2.27

10. Transactions with Related Parties

Management Fees

The Company is externally managed by Atlantic Capital Advisors LLC (“ACA”) pursuant to a management agreement (the “Management Agreement”). All of the Company’s executive officers are also employees of ACA. ACA manages the Company’s day-to-day operations, subject to the direction and oversight of the Company’s Board of Directors which includes four independent directors. The Management Agreement expires on November 5, 2010 and is thereafter automatically renewed for an additional one-year term unless terminated under certain circumstances. ACA must be provided 180 days prior notice of any such termination and will be paid a termination fee equal to three times the average annual management fee earned by ACA during the two year period immediately preceding termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. Certain terminations involving the internalization of the Company’s management, however, may result

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Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

in no or a capped termination fee. Under the terms of the Management Agreement, the Company is responsible for all operating expenses of the Company other than those borne by ACA. ACA is generally responsible for costs incident to the performance of its duties, such as compensation of its employees and overhead expenses (such as rent, utilities, furniture and equipment, bookkeeping and other back office expenses).

ACA is entitled to receive a management fee payable monthly in arrears in an amount equal to 1/12th of an amount determined as follows:

• for the Company’s equity up to $250 million, 1.50% (per annum) of equity; plus

• for the Company’s equity in excess of $250 million and up to $500 million, 1.10% (per annum) of equity; plus

• for the Company’s equity in excess of $500 million and up to $750 million, 0.80% (per annum) of equity; plus

• for the Company’s equity in excess of $750 million, 0.50% (per annum) of equity.

For purposes of calculating the management fee, equity is defined as the value, computed in accordance with GAAP, of shareholders’ equity, adjusted to exclude the effects of unrealized gains or losses. For the three months ended June 30, 2010 and 2009, the Company incurred $2,195 and $2,166 in management fees, respectively. For the six months ended June 30, 2010 and 2009, the Company incurred $4,379 and $4,327 in management fees, respectively At June 30, 2010 and December 31, 2009, the Company owed ACA $720 and $730, respectively, for the management fee, which is included in accounts payable and other liabilities.

11. Accumulated Other Comprehensive Income

Accumulated other comprehensive income consists of the following components:

	June 30, 2010			December 30, 2009
Unrealized gain on securities, net	$	228,856		$	188,703
Unrealized gain (loss) on unsettled securities		404			(238	)
Unrealized loss on derivative instruments		(71,947	)		(35,742	)
Accumulated other comprehensive income	$	157,312		$	152,723

The Company records unrealized gains and losses on its MBS and swap positions as is described in Notes 4 and 7, respectively.

Comprehensive income for the three and six months ended June 30, 2010 and 2009 consists of the following components:

	Three months ended					Six months ended
	June 30, 2010			June 30, 2009		June 30, 2010			June 30, 2009
Net Income	$	36,812		$	43,496	$	80,546		$	82,305
Unrealized gain on securities		38,881			33,938		40,794			101,210
Unrealized loss on derivative instruments		(24,824	)		23,733		(36,205	)		22,723
Comprehensive income	$	50,869		$	101,167	$	85,135		$	206,238

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Hatteras Financial Corp.

Notes to Financial Statements—(Continued)

June 30, 2010

(Dollars in thousands except per share amounts)

12. Subsequent Events

On July 8, 2010, the compensation and governance committee of the board of directors of the Company approved the grant of an aggregate of 88,807 shares of time-based restricted stock to its executive officers under the Company’s 2007 Equity Incentive Plan. The shares are scheduled to vest ratably on an annual basis over a five-year period. All of the awards are issued and outstanding as of the grant date and the awardee is entitled to receive dividends as declared and paid on the shares and to vote the shares from the date of grant.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In this quarterly report on Form 10-Q, we refer to Hatteras Financial Corp. as “we,” “us,”“our company,” or “our,” unless we specifically state otherwise or the context indicates otherwise. The following defines certain of the commonly used terms in this quarterly report on Form 10-Q: “RMBS” refers to residential mortgage-backed securities; “agency RMBS” and “agency securities” refer to our RMBS that are issued or guaranteed by a U.S. Government sponsored entity, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae; “hybrids” and “hybrid ARMs” refer to hybrid mortgage loans that have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; and “ARMs” refers to hybrids after the fixed rate period expires and adjustable-rate mortgage loans which typically at all times have interest rates that adjust annually to an increment over a specified interest rate index.

The following discussion should be read in conjunction with our financial statements and accompanying notes included in Item 1 of this quarterly report on Form 10-Q as well as our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission (“SEC”) on February 19, 2010.

Forward-Looking Statements

When used in this quarterly report on Form 10-Q, in future filings with the SEC or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions, are intended to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, as such, may involve known and unknown risks, uncertainties and assumptions.

Forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. The following factors could cause actual results to vary from our forward-looking statements: changes in interest rates and the market value of our agency securities; changes in the prepayment rates on the mortgage loans securing our agency securities; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended (the “Investment Company Act”); and risks associated with investing in real estate assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they

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are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We are a mortgage REIT that primarily invests in adjustable-rate and hybrid adjustable-rate single-family residential mortgage pass-through securities guaranteed or issued by a U.S. Government agency (such as the Government National Mortgage Association, “Ginnie Mae”), or by a U.S. Government-sponsored entity (such as the Federal National Mortgage Association, “Fannie Mae”, and the Federal Home Loan Mortgage Corporation, “Freddie Mac”). We were incorporated in Maryland in September 2007 and commenced operations in November 2007 upon completion of our initial private issuance of common stock. We completed our initial public offering in April 2008, and listed our common stock on the NYSE under the symbol “HTS”. We are managed and advised by our manager, Atlantic Capital Advisors LLC.

Our principal goal is to generate net income for distribution to our shareholders, through regular quarterly dividends, from the difference between the interest income on our investment portfolio and the interest costs of our borrowings and hedging activities, which we refer to as our net interest income, and other expenses. In general, our strategy is to manage interest rate risk while trying to eliminate exposure to credit risk. We believe that the best approach to generating a positive net interest income is to manage our liabilities in relation to the interest rate risks of our investments. To help achieve this result, we employ repurchase financing, generally short-term, and combine our financings with hedging instruments, relying primarily on interest rate swaps. We may, subject to maintaining our REIT qualification, also employ other hedging techniques from time to time, including interest rate caps, floors and swaptions to mitigate the effects of adverse interest rate movements.

We focus on agency securities consisting of hybrid adjustable-rate residential mortgage loans with short effective durations, which we believe reduces the impact of changes in interest rates on the market value of our portfolio and on our net interest income. However, because our investments vary in interest rate, prepayment speed and maturity, the leverage or borrowings that we employ to fund our asset purchases will never exactly match the terms or performance of our assets, even after we have employed our hedging techniques. Based on our manager’s experience, the interest rates of our assets will change more slowly than the corresponding short-term borrowings used to finance our assets. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income and shareholders’ equity.

Since our formation, virtually all of our invested assets have been in agency securities. These agency securities principally consist of whole-pool, pass-through certificates that are backed by ARMs and hybrid ARMs that have principal and interest payments guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac. ARMs have interest rates that reset monthly, quarterly and annually, based on the 12-month moving average of the one-year constant maturity U.S. Treasury rate or LIBOR. Hybrid ARMs have interest rates that are fixed for a longer initial period (typically three, five, seven or 10 years) and, thereafter, generally adjust annually to an increment over a pre-determined interest rate index. As of June 30, 2010, our portfolio consisted of approximately $6.8 billion in market value of agency RMBS with a weighted average initial fixed-interest rate period of 44 months.

We are organized and conduct our operations to qualify as a REIT under the Code, and generally are not subject to federal taxes on our income to the extent we currently distribute our income to our shareholders and maintain our qualification as a REIT.

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The following table represents key data regarding our company since the beginning of operations on November 5, 2007:

(in thousands except per share amounts)

As of	Agency Securities (1)		Repurchase Agreements		Equity		Shares Outstanding	Book Value Per Share		Quarterly Weighted Average Earnings Per Share
June 30, 2010	$	7,651,266	$	5,982,998	$	965,619	37,388	$	25.83	$	1.01
March 31, 2010	$	7,125,065	$	6,102,661	$	929,433	36,472	$	25.48	$	1.21
December 31, 2009	$	7,038,987	$	6,346,518	$	931,713	36,200	$	25.74	$	1.28
September 30, 2009	$	7,303,441	$	6,007,909	$	943,597	36,200	$	26.07	$	1.26
June 30, 2009	$	6,699,512	$	5,496,854	$	865,204	36,200	$	23.90	$	1.20
March 31, 2009	$	6,329,731	$	5,250,382	$	803,575	36,192	$	22.20	$	1.07
December 31, 2008	$	5,211,730	$	4,519,435	$	736,287	36,186	$	20.35	$	0.73
September 30, 2008	$	4,974,648	$	4,569,262	$	527,220	26,777	$	19.69	$	1.11
June 30, 2008	$	5,097,189	$	4,387,739	$	561,176	26,777	$	20.96	$	0.88
March 31, 2008	$	3,036,826	$	2,739,631	$	329,400	15,268	$	21.57	$	0.71
December 31, 2007	$	1,619,290	$	1,475,512	$	165,356	8,368	$	19.76	$	0.15

(1) Includes unsettled purchases and forward commitments to purchase

Factors that Affect our Results of Operations and Financial Condition

Our results of operations and financial condition are affected by various factors, many of which are beyond our control, including, among other things, our net interest income, the market value of our assets and the supply of and demand for such assets. We invest in financial assets and markets, and recent events, such as those discussed below, can affect our business in ways that are difficult to predict, and produce results outside of typical operating variances. Our net interest income varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. Prepayment rates, as reflected by the rate of principal paydown, and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment rates on our agency securities purchased at a premium increase, related purchase premium amortization increases, thereby reducing the net yield on such assets. Because changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to manage interest rate risks and prepayment risks effectively while maintaining our status as a REIT.

We anticipate that, for any period during which changes in the interest rates earned on our assets do not coincide with interest rate changes on our borrowings, such assets will reprice more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net interest income. With the maturities of our assets generally of longer term than those of our liabilities, interest rate increases will tend to decrease our net interest income and the market value of our assets (and therefore our book value). Such rate increases could possibly result in operating losses or adversely affect our ability to make distributions to our shareholders.

Prepayments on agency securities and the underlying mortgage loans may be influenced by changes in market interest rates and a variety of economic, geographic and other factors beyond our control; and consequently, such prepayment rates cannot be predicted with certainty. To the extent we have acquired agency securities at a

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premium or discount to par, or face value, changes in prepayment rates may impact our anticipated yield. In periods of declining interest rates, prepayments on our agency securities will likely increase. If we are unable to reinvest the proceeds of such prepayments at comparable yields, our net interest income may suffer.

While we intend to use hedging to mitigate some of our interest rate risk, we do not intend to hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations on our ability to insulate our portfolio from all potential negative consequences associated with changes in short-term interest rates in a manner that will allow us to seek attractive net spreads on our portfolio.

In addition, a variety of other factors relating to our business may also impact our financial condition and operating performance. These factors include:

• our degree of leverage;

• our access to funding and borrowing capacity;

• our hedging activities; and

• the REIT requirements, the requirements to qualify for an exemption under the Investment Company Act and other regulatory and accounting policies related to our business.

Our manager is entitled to receive a management fee that is based on our equity (as defined in our management agreement), regardless of the performance of our portfolio. Accordingly, the payment of our management fee may not decline in the event of a decline in our profitability and may cause us to incur losses.

For a discussion of additional risks relating to our business see “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009.

Market and Interest Rate Trends and the Effect on our Portfolio

Credit Market Disruption

During the past two years, the residential housing and mortgage markets in the United States have experienced a variety of difficulties and changed economic conditions including loan defaults, credit losses and decreased liquidity. These conditions have resulted in volatility in the value of the agency securities in our portfolio and an increase in the average collateral requirements under our repurchase agreements. Liquidating sales by several large institutions increased the volatility of many financial assets, including agency securities and other high-quality RMBS. As a result, values for RMBS, including some agency securities, were negatively impacted. Further increased volatility and deterioration in the broader residential mortgage and RMBS markets may adversely affect the performance and market value of the agency securities in which we invest. In addition, we rely on the availability of financing to acquire agency securities on a leveraged basis. As values for certain types of agency securities declined many lenders in the agency securities market tightened their lending standards, and in some cases, withdrew financing of residential mortgage assets and agency securities. Our lenders may have owned or financed RMBS that have declined in value and caused them to incur losses. Although market conditions have returned to more normal conditions, if they were to worsen again, our lenders may be forced to exit the repurchase market, or further tighten lending standards or increase the amount of equity capital or “haircut” required to obtain financing, any of which could make it more difficult or costly for us to obtain financing. Furthermore, certain lenders also could become insolvent which could cause us to incur losses.

Developments at Fannie Mae and Freddie Mac

Payments on the agency securities in which we invest are guaranteed by Fannie Mae and Freddie Mac. Because of the guarantee and the underwriting standards associated with mortgages underlying agency securities, agency securities historically have had high stability in value and been considered to present low credit risk. In 2008, Fannie Mae and Freddie Mac were placed under the conservatorship of the U.S. government due to the

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significant weakness of their financial condition. The turmoil in the residential mortgage sector and concern over the future role of Fannie Mae and Freddie Mac has generally decreased price stability of agency securities. In response to the deteriorating financial condition of Fannie Mae and Freddie Mac, Congress and the U.S. Treasury undertook a series of actions in 2008 aimed at stabilizing the financial markets in general, and the mortgage market in particular. These actions include the large-scale buying of mortgage-backed securities, significant equity infusions into banks and aggressive monetary policy.

In February of 2010, Fannie Mae and Freddie Mac announced that they would execute wholesale repurchases of loans which they considered seriously delinquent from existing mortgage pools. Freddie Mac implemented its purchase program in February 2010 with actual purchases beginning in March 2010. Fannie Mae began their process in March 2010 and announced it would implement the initial purchases over a period of four months, beginning in April 2010. Further, both agencies announced that on an ongoing basis they would purchase loans from the pools of mortgage loans underlying their mortgage pass-through certificates that became 120 days delinquent. As a consequence of these actions, the yield on our RMBS decreased during the period of buybacks as we own our securities at a premium to par.

Significant remaining questions exist as to what the ultimate future of the agencies will be and the timing and manner in which the Treasury will resell the RMBS it purchased. We cannot predict whether or when new actions may occur, the timing and pace of current actions already implemented, or what impact if any, such actions, or future actions, could have on our business, results of operations and financial condition.

Interest Rates

The overall credit market deterioration which began in 2007, followed by the recession in the United States, has also affected prevailing interest rates, which at times were unusually volatile in 2007 and 2008. Beginning in September 2007, the U.S. Federal Reserve lowered the target for the Federal Funds Rate nine times from 5.25% to 1.0% by October 2008. In December 2008, the Federal Reserve stated that it was adopting a policy of “quantitative easing” and would target keeping the Federal Funds Rate between 0 and 0.25%. Our funding costs, which traditionally have tracked the 30-day London Interbank Offered Rate (“LIBOR”) have generally benefited by this easing of monetary policy, although to a somewhat lesser extent. Because of continued uncertainty in the credit markets and U.S. economic conditions, we expect that interest rates may experience unusual volatility, which would likely affect our financial results since our cost of funds is largely dependent on short-term rates.

Historically, the 30-day LIBOR, has closely tracked movements in the Federal Funds Rate. Our borrowings in the repurchase market have also historically closely tracked LIBOR. So traditionally, a lower Federal Funds rate has indicated a time of increased net interest margin and higher asset values. However, starting in July 2007 (prior to our commencement of operations) LIBOR and repurchase market rates have often been significantly higher than the target Federal Funds Rate. The difference between 30-day LIBOR and the Federal Funds rate has been quite volatile, with the spread alternately returning to more normal levels and then widening out again. Towards the end of the third quarter of 2008 this difference increased to historically high levels. Although in mid-2009 this difference returned to more normal levels, any excess volatility in these rates or divergence from the historical relationship among these rates could negatively impact our ability to manage our portfolio. If this were to occur, our net interest margin and the value of our portfolio might suffer as a result. The following table shows the 30-day LIBOR as compared to the Federal Funds rate at each period end:

	30-Day LIBOR		Federal Funds
June 30, 2010	0.35	%	0.25	%
March 31, 2010	0.25	%	0.25	%
December 31, 2009	0.23	%	0.25	%
September 30, 2009	0.25	%	0.25	%
June 30, 2009	0.31	%	0.25	%
March 31, 2009	0.50	%	0.25	%
December 31, 2008	0.44	%	0.25	%
September 30, 2008	3.93	%	2.00	%
June 30, 2008	2.46	%	2.00	%
March 31, 2008	2.70	%	2.25	%
December 31, 2007	4.60	%	4.25	%

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Principal Repayment Rate

Our net income is primarily a function of the difference between the yield on our assets and the financing cost of owning those assets. Since we tend to purchase assets at a premium to par, the main factor that can affect the yield on our assets after they are purchased is the rate at which the mortgage borrowers repay the loan. While the scheduled repayments, which are the principal portion of the homeowners’ regular monthly payments, are fairly predictable, the unscheduled repayments, which are generally refinancing of the mortgage, are less so. Being able to accurately estimate and manage these repayment rates is a critical portion of the management of our portfolio, not only for estimating current yield but also to consider the rate of reinvestment of those proceeds into new securities and the yields which those new securities may add to our portfolio. The Freddie Mac and Fannie Mae programs to buyback delinquent mortgages have caused and may continue to cause unpredictable prepayments. The effect of these programs is shown in the marked increase in the repayment rate for the first two quarters of 2010. The following table shows the average principal repayment rate for each quarter since our commencement of operations:

Quarter ended	Average Quarterly  Principal Repayment Rate	Average Rate Annualized
June 30, 2010	11.27%	45.08%
March 31, 2010	9.01%	36.04%
December 31, 2009	5.67%	22.70%
September 30, 2009	5.56%	22.26%
June 30, 2009	5.23%	20.93%
March 31, 2009	3.09%	12.36%
December 31, 2008	1.96%	7.84%
September 30, 2008	2.12%	8.46%
June 30, 2008	3.14%	12.57%
March 31, 2008	3.90%	15.61%

Capital Raising Activity

From time to time, we may raise additional capital to take advantage of investing and hedging opportunities, provide permanent funding, provide additional liquidity, or other activities that our Board of Directors may deem appropriate. On October 9, 2009, we entered into a Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co. (“Cantor”) to create a controlled equity offering program (the “CEO Program”). Under the terms of the Sales Agreement, we may offer and sell up to 5,000,000 shares of our common stock from time to time through Cantor, acting as agent and/or principal. During the three months ended June 30, 2010, we issued 916,500 shares of common stock at an average price of $29.03 per share under our CEO Program. We believe that having a diverse range of capital sources is important for long-term stability and growth, and we may raise more capital in future periods, subject to market conditions and investing opportunities.

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Book Value per Share

As of June 30, 2010, our book value per share of common stock (total shareholders’ equity divided by shares of common stock outstanding) was $25.83, an increase of $0.09 from $25.74 at December 31, 2009. Declining U.S. Treasury securities rates, U.S. government actions, particularly the large-scale purchasing of agency securities, and stable financial markets have increased values on our securities to historically high levels. Offsetting this increase in RMBS values, the value of our interest rate swaps fell by a nearly equal amount as we increased our total position and the long term outlook for interest rates decreased. Our interest rate swaps, which fix the borrowing cost on a portion of our financing, generally help mitigate changes in our book value. Generally, the value of our interest rate swaps moves in the opposite direction of the value of our agency securities, as was the case in the first six months of 2010. The following table shows the components of our book value at each period end:

As of	Common Equity		Undistributed Earnings		Unrealized Gain/(Loss) on RMBS		Unrealized Gain/(Loss) on Interest Rate Swaps		Book Value Per Share
June 30, 2010	$	21.50	0.12		6.36		(2.15	)	$	25.83
March 31, 2010	$	21.32	0.24		5.25		(1.33	)	$	25.48
December 31, 2009	$	21.28	0.24		5.21		(0.99	)	$	25.74
September 30, 2009	$	21.27	0.16		5.96		(1.32	)	$	26.07
June 30, 2009	$	21.26	0.05		3.69		(1.10	)	$	23.90
March 31, 2009	$	21.26	(0.05	)	2.75		(1.76	)	$	22.20
December 31, 2008	$	21.26	(0.08	)	0.90		(1.73	)	$	20.35
September 30, 2008	$	21.37	0.12		(1.88	)	0.08		$	19.69
June 30, 2008	$	21.37	0.06		(0.75	)	0.28		$	20.96
March 31, 2008	$	20.72	0.44		0.55		(0.14	)	$	21.57
December 31, 2007	$	18.79	0.15		0.82		—		$	19.76

Investments

Agency Securities

As of June 30, 2010 and December 31, 2009, our agency securities portfolio was purchased at a net premium to par, or face value, with a weighted-average amortized cost of 101.58 and 101.52, respectively, of face value, due to the average interest rates on these securities being higher than prevailing market rates. As of June 30, 2010 and December 31, 2009, we had approximately $102.1 million and $101.8 million, respectively, of unamortized premium included in the cost basis of our investments.

As of June 30, 2010, our investment portfolio consisted of agency securities as follows:

(dollars in thousands) Months to Reset	% of Portfolio		Current Face value (1)		Weighted Avg. Coupon (2)		Weighted  Avg. Amortized Purchase Price (3)		Amortized Cost (4)		Weighted Avg. Market  Price (5)		Market Value (6)
0-36	41.7	%	$	2,683,566	4.99	%	$	101.40	$	2,721,093	$	105.42	$	2,828,926
37-60	52.0	%		3,365,856	4.28	%	$	101.72		3,423,655	$	104.98		3,533,326
61-84	5.7	%		372,652	4.15	%	$	101.67		378,883	$	104.45		389,235
85-120	0.6	%		38,647	4.05	%	$	101.46		39,213	$	104.05		40,214
Total MBS	100.0	%	$	6,460,721	4.56	%	$	101.58	$	6,562,845	$	105.12	$	6,791,701

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As of December 31, 2009, our investment portfolio consisted of agency securities as follows:

(dollars in thousands) Months to Reset	% of Portfolio		Current Face value (1)		Weighted Avg. Coupon (2)		WeightedAvg. Amortized Purchase Price (3)		Amortized Cost (4)		Weighted Avg. Market  Price (5)		Market Value (6)
0-36	27.0	%	$	1,806,515	5.23	%	$	101.44	$	1,832,477	$	104.84	$	1,893,992
37-60	53.2	%		3,573,897	4.63	%	$	101.58		3,630,320	$	104.02		3,717,454
61-84	19.6	%		1,307,937	5.00	%	$	101.46		1,327,045	$	104.52		1,367,106
85-120	0.2	%		13,953	4.38	%	$	101.95		14,226	$	101.90		14,219
Total MBS	100.0	%	$	6,702,302	4.86	%	$	101.52	$	6,804,068	$	104.33	$	6,992,771

⁽¹⁾ The current face value is the current monthly remaining dollar amount of principal of a mortgage security. We compute current face value by multiplying the original face value of the security by the current principal balance factor. The current principal balance factor is essentially a fraction, where the numerator is the current outstanding balance and the denominator is the original principal balance.

⁽²⁾ For a pass-through certificate, the coupon reflects the weighted average nominal rate of interest paid on the underlying mortgage loans, net of fees paid to the servicer and the agency. The coupon for a pass-through certificate may change as the underlying mortgage loans are prepaid. The percentages indicated in this column are the nominal interest rates that will be effective through the interest rate reset date and have not been adjusted to reflect the purchase price we paid for the face amount of security.

⁽³⁾ Amortized purchase price is the dollar amount, per $100 of current face, of our purchase price for the security, adjusted for amortization as a result of scheduled and unscheduled principal paydowns.

⁽⁴⁾ Amortized cost is our total purchase price for the mortgage security, adjusted for amortization as a result of scheduled and unscheduled principal paydowns.

⁽⁵⁾ Market price is the dollar amount of market value, per $100 of nominal, or face, value, of the mortgage security. Under normal conditions, we compute market value by obtaining valuations for the mortgage security from separate and independent sources and averaging three valuations.

⁽⁶⁾ Market value is the total market value for the mortgage security. Under normal conditions, we compute market value by obtaining valuations for the mortgage security from separate and independent sources and averaging three valuations.

Our investment portfolio consisted of the following breakdown between Fannie Mae and Freddie Mac at June 30, 2010 and December 31, 2009:

	June 30, 2010				December 31, 2009
(dollars in thousands)	Estimated Fair Value		% of Total		Estimated Fair Value		% of Total
Agency MBS
Fannie Mae Certificates	$	4,824,706	71.0	%	$	4,976,790	71.2	%
Freddie Mac Certificates		1,966,995	29.0	%		2,015,981	28.8	%
Total MBS	$	6,791,701			$	6,992,771

As of June 30, 2010 and December 31, 2009, the hybrid ARM mortgage loans underlying our agency securities had fixed interest rates for an average period of approximately 45 months, after which time the interest rates reset and become adjustable. After the reset date, interest rates on our hybrid ARM agency securities float based on spreads over various indices, usually LIBOR or the one-year Constant Maturity Treasury(“CMT”) rate. These interest rates are subject to caps that limit the amount the applicable interest rate can increase (or decrease) during any year, known as an annual cap, and through the maturity of the security, known as a lifetime cap. The average annual cap on changes to the interest rates on our agency securities is generally 5% at the first reset date, and 2% per year at each successive annual reset date. The average lifetime cap on changes to the interest rates on our agency securities is generally 5% from the initial stated rate.

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Liabilities

We have entered into repurchase agreements to finance most of our agency securities. Our repurchase agreements are secured by our agency securities and bear interest at rates that have historically moved in close relationship to LIBOR. As of June 30, 2010 and December 31, 2009, we had 24 and 23 borrowing relationships, respectively, with various investment banking firms and other lenders. We had outstanding balances under our repurchase agreements at June 30, 2010 and December 31, 2009 of $6.0 billion and $6.3 billion, respectively. As part of our risk management strategy, we continue to seek additional new relationships to help mitigate counterparty credit risk and keep borrowing rates competitive.

Hedging Instruments

We generally intend to employ interest rate derivatives on the basis of our managers’ discretion, adjusting our hedge coverage in response to changing market opportunities and prospects. No assurance can be given that our hedging activities will have the desired impact on our results of operations or financial condition. Our policies do not contain specific requirements as to the percentages or amount of interest rate risk that our manager is required to hedge.

Interest rate hedging may fail to protect or could adversely affect us because, among other things:

• available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;

• the duration of the hedge may not match the duration of the related liability;

• the party owing money in the hedging transaction may default on its obligation to pay;

• the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and

• the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value. Downward adjustments, or “mark-to-market losses,” would reduce our shareholders’ equity.

As of June 30, 2010, we had entered into 34 interest rate swap agreements designed to lock in funding costs for specific funding activities associated with specific assets, in such a way as to assure realizing attractive net interest margins. Such hedges incorporate an assumed prepayment schedule, which, if not realized, will cause hedge results to differ from expectations. These swap agreements provide for fixed interest rates indexed off of one-month LIBOR and effectively fix the floating interest rates on $3.4 billion of borrowings under our repurchase agreements. We also currently have four longer-term repurchase agreements, totaling $300.0 million, as a means of hedging our interest rate exposure.

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Summary Financial Data

	Three months ended (unaudited)						Six months ended (unaudited)
(in thousands, except per share amounts)	June 30,2010			June 30,2009			June 30,2010			June 30,2009
Balance Sheet Data
Total Assets	$	7,120,463		$	6,935,113		$	7,120,463		$	6,935,113
Long Term Repurchase Agreements	$	5,982,998		$	5,496,854		$	5,982,998		$	5,496,854
Statement of Income Data
Interest income	$	63,739		$	69,806		$	132,957		$	137,641
Interest Expense		(23,677	)		(23,301	)		(47,117	)		(49,297	)
Net Interest Income		40,062			46,505			85,840			88,344
Gain on sale of mortgage-backed securities		—			—			1,044			—
Operating Expenses		(3,250	)		(3,009	)		(6,338	)		(6,039	)
Net Income	$	36,812		$	43,496		$	80,546		$	82,305
Earnings per share -common stock, basic and diluted	$	1.01		$	1.20		$	2.21		$	2.27
Weighted average shares outstanding		36,609			36,193			36,427			36,192
Cash dividends declared per common share	$	1.10		$	1.10		$	2.30		$	2.15
Key Portfolio Statistics*
Average RMBS(1)	$	6,591,086		$	5,917,582		$	6,661,653		$	5,721,944
Average Repurchase Agreements(2)	$	6,092,328		$	5,359,086		$	6,157,265		$	5,173,433
Average Equity(3)	$	942,018		$	847,728		$	941,969		$	817,024
Average Portfolio Yield(4)		3.85	%		4.71	%		3.97	%		4.80	%
Average Cost of Funds(5)		1.55	%		1.74	%		1.53	%		1.91	%
Interest Rate Spread(6)		2.30	%		2.97	%		2.44	%		2.89	%
Return on Average Equity(7)		15.63	%		20.96	%		17.10	%		20.37	%
Average Annual Portfolio Repayment Rate (8)		45.08	%		20.93	%		40.52	%		16.79	%
Debt to Equity(at period end)(9)		6.2:1			6.4:1			6.2:1			6.4:1
Debt to Additional Paid in Capital (at period end) (10)		7.4:1			7.1:1			7.4:1			7.1:1

^* Average numbers for each period are weighted based on days on our books and records. All percentages are annualized.

⁽¹⁾ Our daily average investment in agency RMBS for the quarter was calculated by dividing the sum of our daily agency RMBS investments during the quarter by the number of days in that period.

⁽²⁾ Our daily average balance outstanding under our repurchase agreements for the period was calculated by dividing the sum of our daily outstanding balances under our repurchase agreements during the period by the number of days in that period.

⁽³⁾ Our daily average shareholders’ equity for the period was calculated by dividing the sum of our daily shareholders’ equity during the period by the number of days in that period.

⁽⁴⁾ Our average portfolio yield for the period was calculated by dividing our net interest income by our average agency RMBS.

⁽⁵⁾ Our average cost of funds for the period was calculated by dividing our total interest expense (including hedges) by our average borrowings.

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⁽⁶⁾ Our interest rate spread for the period was calculated by subtracting our average cost of funds from our average portfolio yield.

⁽⁷⁾ Our return on average equity for the period was calculated by dividing net income by average equity.

⁽⁸⁾ Our average annual principal repayment rate was calculated by dividing our total principal payments received during the period (scheduled and unscheduled) by our average RMBS.

⁽⁹⁾ Our debt to equity ratio for the period was calculated by dividing the amount outstanding under our repurchase agreements by total shareholders’ equity.

⁽¹⁰⁾ Our debt to additional paid in capital ratio for the period was calculated by dividing the amount outstanding under our repurchase agreements by additional paid in capital.

Results of Operations

Three months ended June 30, 2010 and 2009

Our primary source of income is the interest income we earn on our investment portfolio. Our interest income for the quarter ended June 30, 2010 was $63.7 million, as compared to $69.8 million for the quarter ended June 30, 2009. Several factors contributed to this decline, but the most significant item was the delinquent loan repurchase program initiated by Fannie Mae and Freddie Mac earlier in 2010. What appears at this time to be a largely one-time event significantly lowered our yield for several months. While the program began in March 2010 and will have some lingering effects in the third quarter of 2010 as well, from an earnings standpoint, we believe the direct impact of this program was largely a second quarter event. Although our average earning assets increased, growing from $5.9 billion for the second quarter of 2009 to $6.6 billion for the second quarter of 2010, our yield was meaningfully lower. Our annualized yield of average assets was 3.85% and 4.71%, respectively, for the quarters ended June 30, 2010 and 2009. This decrease reflects the decline of overall mortgage rates on new securities purchased throughout the last year plus an increase in our amortization expense due to the buyback programs discussed above. These factors combined to lower the total income generated by the larger portfolio.

The yield on our assets is directly affected by the rate of repayments on our agency securities. Our annualized rate of portfolio repayment for the three months ended June 30, 2010 was 45.08%, which was more than double the rate from the three months ended June 30, 2009 rate of 20.93%. Again, while a variety of factors contributed to this increase, the primary factor was the Fannie Mae and Freddie Mac delinquent loan buybacks. Overall, our rate of prepayments has trended higher in the last year due to low mortgage rates and government programs to encourage housing finance along with the overall seasoning of our RMBS portfolio. It is difficult to estimate repayment speeds for future periods, especially in the current economic environment. Historically, when mortgage rates fall dramatically, the prepayment of the underlying mortgages has tended to increase significantly. However, the current U.S. economic and housing markets have inhibited, and may continue to inhibit, the homeowner’s ability to purchase a new home or refinance an existing mortgage, keeping these rates slower than normal. On the other hand, the U.S. government has been significantly active in the mortgage market in an attempt to promote national housing market stability and economic growth. Their ability to dramatically alter the mortgage market poses a significant risk to the sustainability of our current earnings. One of the ways that we try to mitigate the risk of high repayment speeds on our assets is to keep the price of our portfolio as close to par as possible, as changes in repayment speeds have a lesser affect on income than a higher price portfolio. At June 30, 2010, our portfolio had an average dollar price of $101.58 per $100 of face value.

Our interest expense for the quarter ended June 30, 2010 was $23.7 million as compared to $23.3 million for the quarter ended June 30, 2009. Our average borrowings increased from $5.4 billion for the quarter ended June 30, 2009 to $6.1 billion for the quarter ended June 30, 2010, due to the increase in portfolio size. Despite this increase in borrowings, our total interest expense was essentially unchanged. This was due to decreases in both short-term and long-term interest rates and hedging costs which are associated with funding our portfolio. Our annualized average cost of funds, including hedges, was 1.55% for the quarter ended June 30, 2010, as compared to 1.74% for the quarter ended June 30, 2009.

Our net interest income for the quarter ended June 30, 2010 was $40.1 million, and our net interest margin, or “spread”, was 2.30%. For the quarter ended June 30, 2009 our net interest income was $46.5 million and our spread was 2.97%. This decrease in our spread was due to our decreased yield, as described above, mitigated somewhat by a lower cost of funds, as compared to a year ago. While the dollar figure is more influenced by the size or our portfolio and overall interest rate levels, we believe our spread is the more important indicator of our performance.

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Our total operating expenses for the quarter ended June 30, 2010 and 2009 were $3.3 million and $3.0 million, respectively. This equates to an annualized expense ratio of 138 and 142 basis points, respectively, of average equity. While we held expenses basically constant, the increase in our average equity, which was due to higher securities prices, decreased the ratio as compared to a year ago.

Our net income for the quarter ended June 30, 2010 was $36.8 million or $1.01 per diluted share. This represents an annualized return on average equity of 15.63% for the period. For the quarter ended June 30, 2009, our net income was $43.5 million or $1.20 per diluted share, and the annualized return on average equity was 20.96%. While many factors may affect these numbers, the decrease in the per share earnings was due primarily to two factors. First, we had a lower yielding portfolio which resulted (1) directly from the Fannie Mae and Freddie Mac delinquent loan buybacks and an increasing in refinancing, and (2) indirectly from investing in increasingly lower coupon securities and the timing of those purchases. Second, as our equity per share has increased, due to higher security prices, mathematically our return on equity decreased. Our leverage, which can significantly affect our earnings, during the quarter ended June 30, 2010, averaged around 6.4:1. We have maintained a lower leverage than we might at times due to having a defensive posture against future rate increases and to preserve liquidity as there are still significant unknowns in the financial markets, including government intervention in our industry, especially as it relates to prepayment speeds. Our leverage ratio will increase when asset prices drop, making some of the apparent safety of low leverage temporary.

Six months ended June 30, 2010 and 2009

In general, most of the items influencing our operating results for the six month periods ended June 30, 2010 and 2009 were similar as the items affecting the quarterly results described above. For the six month period ended June 30, 2010 we had interest income of $133.0 million compared to $137.6 million for the same period in 2009. Our portfolio was significantly larger during this period, as we had average earning assets of $6.7 billion for the six months ended June 30, 2010 compared to $5.7 billion for the six months ended June 30, 2009. While the total RMBS at the end of each period was fairly similar, the average earning assets was lower in the first half of 2009 due to the time it took to invest the proceeds from our December 2008 equity raise. Offsetting this increase in earning assets was a lower yield on the portfolio. Our yield dropped from 4.80% for the six months ended June 30, 2009 to 3.97% for the six months ended June 30, 2010. This was the result of buying lower coupon RMBS to replace repayments combined with an increase in the portfolio prepayment rate, which rose, on an annualized basis, from 16.79% for the first six months of 2009 to 40.52% for the same period in 2010. Low mortgage rates, which encourage refinancing, and the Fannie Mae and Freddie Mac delinquent loan repurchase program were the primary cause of the increase in our rate of repayment.

Our interest expense for the six months ended June 30, 2010 was $47.1 million as compared to $49.3 million for the six months ended June 30, 2009. While our average borrowings increased proportionately along with our assets, the interest rates we pay on these borrowing were lower on average during the first half of 2010. Our average cost of funds, including hedges, fell from 1.91% for the six months ended June 30, 2009 to 1.53% for the same period in 2010.

Our net interest income for the six months ended June 30, 2010 was $85.8 million, and our spread was 2.44%. For the six months ended June 30, 2009, our net interest income was $88.3 million and our spread was 2.89%. We incurred expenses for the six months ended June 30, 2010 and 2009 of $6.3 million and $6.0 million, respectively.

We earned net income of $80.5 million or $2.21 per weighted average share for the six months ended June 30, 2010. For the six months ended June 30, 2009, we earned net income of $82.3 million or $2.27 per weighted average share.

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Contractual Obligations and Commitments

We had the following contractual obligations under repurchase agreements as of June 30, 2010 and December 31, 2009 (dollar amounts in thousands):

	June 30, 2010
(dollars in thousands)	Balance		Weighted Average Contractual Rate		Contractual Interest Payments		Total Contractual Obligation
Within 30 days	$	5,682,998	0.28	%	$	1,090	$	5,684,088
30 days to 3 months		—	—			—		—
3 months to 36 months		300,000	3.06	%		6,990		306,990
	$	5,982,998	0.42	%	$	8,080	$	5,991,078

	December 31, 2009
	Balance		Weighted Average Contractual Rate		Contractual Interest Payments		Total Contractual Obligation
Within 30 days	$	5,946,518	0.24	%	$	975	$	5,947,493
30 days to 3 months		—	—			—		—
3 months to 36 months		400,000	3.01	%		12,520		412,520
	$	6,346,518	0.41	%	$	13,495	$	6,360,014

In addition, we had contractual commitments under interest rate swap agreements as of June 30, 2010. These agreements were for a total notional amount of $3.4 billion, had a weighted average rate of 2.61% and a weighted average term of 29 months.

Off-Balance Sheet Arrangements

As of June 30, 2010 and December 31, 2009, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, as of June 30, 2010 and December 31, 2009, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.

Liquidity and Capital Resources

Our primary sources of funds are borrowings under repurchase arrangements and monthly principal and interest payments on our investments. Other sources of funds may include proceeds from debt and equity offerings and asset sales. We generally maintain liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage our long-term investment capital. Because the level of these borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on the balance sheet is significantly less important than our potential liquidity available under our borrowing arrangements. We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings and the payment of cash dividends as required for continued qualification as a REIT.

In response to the growth of our agency securities portfolio and to recent turbulent market conditions, we have aggressively pursued additional lending counterparties in order to help increase our financial flexibility and ability to withstand periods of contracting liquidity in the credit markets. At June 30, 2010 we had uncommitted repurchase facilities with 24 lending counterparties to finance this portfolio, subject to certain conditions, and have borrowings outstanding with 20 of these counterparties.

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Under the terms of our Sales Agreement for our CEO Program, we may offer and sell up to 5,000,000 shares of our common stock from time to time through Cantor acting as agent and/or principal. Sales of the shares of common stock, if any, may be made in private transactions, negotiated transactions or any method permitted by law deemed to be an “at the market” offering as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or to or through a market maker other than on an exchange. Under the Sales Agreement, Cantor will use its commercially reasonable efforts consistent with its normal sales and trading practices to sell the shares of common stock as directed by us. The compensation payable to for sales of shares of common stock pursuant to the Sales Agreement will be up to 2% of the gross sales price per share for any shares sold under the Sales Agreement.

During the three and six months ended June 30, 2010, we issued 916,500 and 1,181,500, respectively, shares of common stock in at-the-market transactions at an average price of $29.03 and $28.60 per share, respectively, raising net proceeds, after sales commissions and fees, of approximately $26.1 million and $33.0 million, respectively. The shares of common stock issuable pursuant to the CEO Program are registered with the SEC on our Registration Statement on Form S-3 (No. 333-159145), which became effective upon filing on October 9, 2009.

Liquidity Sources—Repurchase Facilities

With repurchase facilities being an integral part of our financing strategy, and thus our financial condition, full understanding of the repurchase market is necessary to understand the risks and drivers of our business. For example, we anticipate that, upon repayment of each borrowing under a repurchase agreement, we will use the collateral immediately for borrowing under a new repurchase agreement. And while we have borrowing capacity under our repurchase facilities well in excess of what is required for our operations, these borrowing lines are uncommitted and generally do not provide long term excess liquidity. Currently, we have not entered into any commitment agreements under which the lender would be required to enter into new repurchase agreements during a specified period of time, nor do we presently plan to have liquidity facilities with commercial banks.

As of June 30, 2010, the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount, which we also refer to as the haircut, under all our repurchase agreements, was approximately 4.69% (weighted by borrowing amount). As of December 31, 2009, our weighted average haircut was 4.80%. Declines in the value of our agency securities portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event under the standard master repurchase agreement would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due by us to the counterparty to be payable immediately.

As discussed above under “—Market and Interest Rate Trends and the Effect on our Portfolio,” over the last two years the residential mortgage market in the United States has experienced difficult conditions including:

• increased volatility of many financial assets, including agency securities and other high-quality RMBS assets, due to news of potential security liquidations;

• increased volatility and deterioration in the broader residential mortgage and RMBS markets; and

• significant disruption in financing of RMBS.

If these conditions persist, our lenders may be forced to exit the repurchase market, become insolvent or further tighten lending standards or increase the amount of haircut, any of which could make it more difficult or costly for us to obtain financing.

Effects of Margin Requirements, Leverage and Credit Spreads

Our agency securities have values that fluctuate according to market conditions and, as discussed above, the market value of our agency securities will decrease as prevailing interest rates or credit spreads increase. When

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the value of the securities pledged to secure a repurchase loan decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a margin call, which means that the lender will require us to pay the margin call in cash or pledge additional collateral to meet that margin call. Under our repurchase facilities, our lenders have full discretion to determine the value of the agency securities we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled paydowns are announced monthly.

We experience margin calls in the ordinary course of our business, and under certain conditions, such as during a period of declining market value for agency securities, we experience margin calls at least monthly. In seeking to manage effectively the margin requirements established by our lenders, we maintain a position of cash and unpledged securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline, we will experience margin calls, and we will use our liquidity to meet the margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls. If our haircuts increase, our liquidity will proportionately decrease. In addition, if we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness.

We intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls but that also allows us to be substantially invested in agency securities. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to liquidate assets into unfavorable market conditions and harm our results of operations and financial condition.

As of June 30, 2010, the weighted average haircut under our repurchase facilities was approximately 4.69%, and our leverage (defined as our debt-to-shareholders equity ratio) was approximately 6.2:1.

Forward-Looking Statements Regarding Liquidity

Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that the net proceeds of our common equity offerings, combined with cash flow from operations and available borrowing capacity, will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as to fund our investment activities, to pay fees under our management agreement, to fund our distributions to shareholders and for general corporate expenses.

Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing and equity capital. We may increase our capital resources by obtaining long-term credit facilities or making public or private offerings of equity or debt securities, possibly including classes of preferred stock, common stock, and senior or subordinated notes. Such financing will depend on market conditions for capital raises and for the investment of any proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations.

We generally seek to borrow (on a recourse basis) between eight and 12 times the amount of our shareholders’ equity. At June 30, 2010 and December 31, 2009, our total borrowings were approximately $6.0 billion and $6.3 billion (excluding accrued interest), respectively, which represented a leverage ratio of approximately 6.2:1 and 6.8:1, respectively.

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 than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP

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and any distributions we may make will be determined by our board of directors based in part on our REIT taxable income as calculated according to the requirements of the Code; in each case, our activities and balance sheet are measured with reference to fair value without considering inflation.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to shareholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

Interest Rate Risk

Interest rate risk is the primary component of our market 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 will be subject to interest rate risk in connection with our investments and our related financing obligations.

Interest Rate Effect on Net Interest Income

Our operating results depend in large part on differences between the yields earned on our investments and our cost of borrowing and hedging activities. The cost of our borrowings will generally be based on prevailing market interest rates. During periods of rising interest rates, the borrowing costs associated with agency securities tend to increase while the income earned on agency securities may remain substantially unchanged until the interest rates reset. This results in a narrowing of the net interest spread between the assets and related borrowings and may even result in losses. 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 investments. 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.

We seek to mitigate interest rate risk through utilization of longer term repurchase agreements and hedging instruments, primarily interest rate swap agreements. Interest rate swap agreements are intended to serve as a hedge against future interest rate increases on our variable rate borrowings. As of June 30, 2010, we had entered into 34 interest rate swap agreements designed to mitigate the effects of increases in interest rates under $3.4 billion of our repurchase agreements.

The selection of hedging instruments is partly based on assumed levels of prepayments of our agency securities. If prepayments are slower or faster than assumed, the life of the agency securities will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns. Hedging techniques are also limited by the rules relating to REIT qualification. In order to preserve our REIT status, we may be forced to terminate a hedging transaction at a time when the transaction is most needed.

Interest Rate Cap Risk

Both the ARMs and hybrid ARMs that underlie our agency securities are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which the security’s interest rate may change during any given period. However, our borrowing costs pursuant to our financing agreements will not be subject to similar restrictions. Therefore, in a period of increasing interest rates, interest rate costs on our borrowings could increase without limitation, while the interest-rate increases on our adjustable-rate and hybrid agency securities could effectively be limited by caps. Agency securities backed by ARMs and hybrid ARMs may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This

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could result in our receipt of less cash from such investments than we would need to pay the interest cost on our related borrowings. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would harm our financial condition, cash flows and results of operations.

Interest Rate Mismatch Risk

We fund a substantial portion of our acquisition of agency securities with borrowings that are based on LIBOR, while the interest rates on these agency securities may be indexed to LIBOR or another index rate, such as the one-year CMT rate. Accordingly, any increase in LIBOR relative to one-year CMT rates will generally result in an increase in our borrowing costs that is not matched by a corresponding increase in the interest earnings on these investments. Any such interest rate index mismatch could adversely affect our profitability, which may negatively impact distributions to our shareholders. To seek to mitigate interest rate mismatches, we may utilize the hedging strategies discussed above.

Our analysis of risks is based on our manager’s experience, estimates and assumptions, including estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our manager may produce results that differ significantly from our manager’s estimates and assumptions.

Prepayment Risk

As we receive repayments of principal on our agency securities from prepayments and scheduled payments, premiums paid on such securities are amortized against interest income and discounts are accreted to interest income. Premiums arise when we acquire agency securities at prices in excess of the principal balance of the mortgage loans underlying such agency securities. Conversely, discounts arise when we acquire agency securities at prices below the principal balance of the mortgage loans underlying such agency securities.

For financial accounting purposes, interest income is accrued based on the outstanding principal balance of the investment securities and their contractual terms. In general, purchase premiums on investment securities are amortized against interest income over the lives of the securities using the effective yield method, adjusted for actual prepayment and cash flow activity. An increase in the principal repayment rate will typically accelerate the amortization of purchase premiums and a decrease in the repayment rate will typically slow the accretion of purchase discounts, thereby reducing the yield/interest income earned on such assets.

Extension Risk

We invest in agency securities backed by hybrid ARMs, which have interest rates that are fixed for the early years of the loan (typically three, five, or seven years) and thereafter reset periodically on the same basis as agency securities backed by ARMs. We compute the projected weighted-average life of our agency securities backed by hybrid ARMs based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgage loans. In general, when agency securities backed by hybrid ARMs are acquired with borrowings, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated weighted-average life of the fixed-rate portion of the related agency securities. This strategy is designed to protect us from rising interest rates by fixing our borrowing costs for the duration of the fixed-rate period of the mortgage loans underlying the related agency securities.

We may structure our interest rate swap agreements to expire in conjunction with the estimated weighted average life of the fixed period of the mortgage loans underlying our agency securities. However, in a rising interest rate environment, the weighted average life of the fixed-rate mortgage loans underlying our agency securities could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the term of the hedging instrument while the income earned on the remaining agency securities would remain fixed for a period of time. This situation may also cause the market value of our agency securities to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.

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Interest Rate Risk and Effect on Market Value Risk

Another component of interest rate risk is the effect changes in interest rates will have on the market value of our agency securities. We face the risk that the market value of our agency securities will increase or decrease at different rates than that of our liabilities, including our hedging instruments.

We primarily assess our interest rate risk by estimating the effective duration of our assets and the effective duration of our liabilities and by estimating the time difference between the interest rate adjustment of our assets and the interest rate adjustment of our liabilities. Effective duration essentially measures the market price volatility of financial instruments as interest rates change. We generally estimate effective duration using various financial models and empirical data. Different models and methodologies can produce different effective duration estimates for the same securities.

The sensitivity analysis tables presented below show 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 and net interest income, at June 30, 2010 and December 31, 2009, assuming a static portfolio. 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 utilized assumptions, models and estimates of the manager based on the manager’s judgment and experience.

June 30, 2010

Change in Interest rates	Percentage Change in Projected Net Interest Income		Percentage Change in Projected Portfolio Value
+1.00%	(4.34	)%	(0.43	)%
+0.50%	(1.89	)%	0.03	%
-0.50%	(0.48	)%	(0.02	)%
-1.00%	(4.67	)%	(0.62	)%

December 31, 2009

Change in Interest Rates	Percentage Change in Projected Net Interest Income		Percentage Change in Projected Portfolio Value
+1.00%	(6.03	)%	(1.47	)%
+0.50%	(1.8	)%	(0.50	)%
-0.50%	(1.29	)%	0.02	%
-1.00%	(3.96	)%	(0.21	)%

While the tables above reflect the estimated immediate impact of interest rate increases and decreases on a static portfolio, we 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 hedging 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 shareholders.

The above table quantifies the potential changes in net interest income and portfolio value, which includes the value of swaps, should interest rates immediately change. Given the low level of interest rates at June 30, 2010 and December 31, 2009, we applied a floor of 0%, for all anticipated interest rates included in our assumptions. Due to presence of this floor, it is anticipated that any hypothetical interest rate decrease would have a limited positive impact on our funding costs beyond a certain level; however, because prepayments speeds are unaffected by this floor, it is expected that any increase in our prepayment speeds (occurring as a result of any interest rate decrease or

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otherwise) could result in an acceleration of our premium amortization and the reinvestment of such prepaid principal in lower yielding assets. As a result, the presence of this floor limits the positive impact of any interest rate decrease on our funding costs. Therefore, at some point, a hypothetical interest rate decreases could cause the fair value of our financial instruments and our net interest income to decline.

Risk Management

To the extent consistent with maintaining our REIT status, we seek to manage our interest rate risk exposure to protect our portfolio of agency securities and related debt against the effects of major interest rate changes. We generally seek to manage our interest rate risk by:

• monitoring and adjusting, if necessary, the reset index and interest rate related to our agency securities and our borrowings;

• attempting to structure our borrowing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;

• using derivatives, financial futures, swaps, options, caps, floors and forward sales to adjust the interest rate sensitivity of our agency securities and our borrowings;

• actively managing, on an aggregate basis, the interest rate indices, interest rate adjustment periods, interest rate caps and gross reset margins of our agency securities and the interest rate indices and adjustment periods of our borrowings; and

• monitoring and managing, on an aggregate basis, our liquidity and leverage to maintain tolerance for market value changes.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We have established disclosure controls and procedures to ensure that material information relating to our company is made known to the officers who certify our financial reports and to the members of senior management and the board of directors.

Based on management’s evaluation as of June 30, 2010, our Chief Executive Officer and Chief Financial Officer believe our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as amended) are effective to ensure that the information required to be disclosed by our company in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes in Internal Control over Financial Reporting

There was no change to our internal control over financial reporting during the second quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II.Other Information

Item 1. Legal Proceedings

Our company and our manager are not currently subject to any material legal proceedings.

Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on February 19, 2010.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. [Removed and Reserved.]

Item 5. Other Information

None.

Item 6. Exhibits

(a) Exhibits.

Exhibit Number	Description of Exhibit
3.1	Articles of Incorporation (1)
3.2	Bylaws (1)
4.1	Form of Stock Certificate (2)
10.1	2010 Equity Incentive Plan (3)
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002
Exhibit 101.INS XBRL	Instance Document (4)
Exhibit 101.SCH XBRL	Taxonomy Extension Schema Document (4)
Exhibit 101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document (4)
Exhibit 101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created (4)
Exhibit 101.LAB XBRL	Taxonomy Extension Label Linkbase Document (4)
Exhibit 101.PRE XBRL	Taxonomy Extension Presentation Linkbase Document (4)

(1) Incorporated by reference to the Registration Statement filed on Form S-11 (File No. 333-149314) filed with the SEC on February 20, 2008, as amended.

(2) Incorporated by reference to Amendment No. 3 to the Registration Statement filed on Form S-11 (File No. 333-149314) filed with the SEC on April 22, 2008.

(3) Incorporated by reference to the Current Report on Form 8-K (File No. 001-34030) filed with the SEC on May 6, 2010.

(4) Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Balance Sheets at June 30, 2010 (Unaudited) and December 31, 2009 (Derived from the audited balance sheet at December 31, 2009); (ii) Statements of Income (Unaudited) for the three and six months ended June 30, 2010 and 2009; (iii) Statement of Changes in Shareholders’ Equity (Unaudited) for the six months ended June 30, 2010; (iv) Statements of Cash Flows (Unaudited) for the six months ended June 30, 2010 and 2009; and (v) Notes to Financial Statements (Unaudited) for the quarter ended June 30, 2010. Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements 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.

	HATTERAS FINANCIAL CORP.
Dated: August 2, 2010	BY:	/S/    KENNETH A. STEELE
		Kenneth A. Steele
		Chief Financial Officer, Treasurer and Secretary
		(Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit Number	Description of Exhibit
3.1	Articles of Incorporation (1)
3.2	Bylaws (1)
4.1	Form of Stock Certificate (2)
10.1	2010 Equity Incentive Plan (3)
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes – Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002
Exhibit 101.INS XBRL	Instance Document (4)
Exhibit 101.SCH XBRL	Taxonomy Extension Schema Document (4)
Exhibit 101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document (4)
Exhibit 101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created (4)
Exhibit 101.LAB XBRL	Taxonomy Extension Label Linkbase Document (4)
Exhibit 101.PRE XBRL	Taxonomy Extension Presentation Linkbase Document (4)

(1) Incorporated by reference to the Registration Statement filed on Form S-11 (File No. 333-149314) filed with the SEC on February 20, 2008, as amended.

(2) Incorporated by reference to Amendment No. 3 to the Registration Statement filed on Form S-11 (File No. 333-149314) filed with the SEC on April 22, 2008.

(3) Incorporated by reference to the Current Report on Form 8-K (File No. 001-34030) filed with the SEC on May 6, 2010.

(4) Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Balance Sheets at June 30, 2010 (Unaudited) and December 31, 2009 (Derived from the audited balance sheet at December 31, 2009); (ii) Statements of Income (Unaudited) for the three and six months ended June 30, 2010 and 2009; (iii) Statement of Changes in Shareholders’ Equity (Unaudited) for the six months ended June 30, 2010; (iv) Statements of Cash Flows (Unaudited) for the six months ended June 30, 2010 and 2009; and (v) Notes to Financial Statements (Unaudited) for the quarter ended June 30, 2010. Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections.