Hatteras Financial (HTS) 10-Q 2011 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, 2011

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, 2011
Common Stock ($0.001 par value)	75,186,570

Hatteras Financial Corp.

Balance Sheets

(In thousands, except per share amounts)	(Unaudited) June 30, 2011			December 31, 2010
Assets
Mortgage-backed securities, at fair value
(including pledged assets of $15,444,263 and $9,089,095 at June 30, 2011 and December 31, 2010, respectively)	$	16,416,897		$	9,587,216
Cash and cash equivalents		233,213			112,626
Restricted cash		159,469			75,422
Unsettled purchased mortgage-backed securities, at fair value		23,995			49,710
Accrued interest receivable		60,502			37,973
Principal payments receivable		91,268			84,151
Debt security, held to maturity, at cost		15,000			15,000
Interest rate hedge asset		4,137			23,944
Other assets		23,208			20,937
Total assets	$	17,027,689		$	10,006,979
Liabilities and shareholders’ equity
Repurchase agreements	$	14,800,594		$	8,681,060
Payable for unsettled securities		23,958			49,774
Accrued interest payable		2,571			3,177
Interest rate hedge liability		117,536			71,681
Dividend payable		75,092			46,116
Accounts payable and other liabilities		1,332			9,687
Total liabilities		15,021,083			8,861,495
Shareholders’ equity:
Preferred stock, $.001 par value, 10,000,000 shares authorized, none outstanding at June 30, 2011 and December 31, 2010		—			—
Common stock, $.001 par value, 100,000,000 shares authorized, 75,091,570 and 46,115,990 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		75			46
Additional paid-in capital		1,861,135			1,043,027
Retained earnings		(1,877	)		(3,480	)
Accumulated other comprehensive income		147,273			105,891
Total shareholders’ equity		2,006,606			1,145,484
Total liabilities and shareholders’ equity	$	17,027,689		$	10,006,979

See accompanying notes.

2

Hatteras Financial Corp.

Statements of Income

(Unaudited)

(In thousands, except per share amounts)	Three months Ended June 30, 2011		Three months Ended June 30, 2010		Six months Ended June 30, 2011		Six months Ended June 30, 2010
Interest income:
Interest income on mortgage-backed securities	$	113,188	$	63,441	$	200,123	$	132,382
Interest income on short-term cash investments		331		298		671		575
Interest income		113,519		63,739		200,794		132,957
Interest expense		35,910		23,677		62,104		47,117
Net interest income		77,609		40,062		138,690		85,840
Other income:
Gain on sale of mortgage-backed securities		4,405		—		4,405		1,044
Operating expenses:
Management fee		3,531		2,196		6,623		4,379
Share based compensation		194		347		401		690
General and administrative		746		707		1,305		1,269
Total operating expenses		4,471		3,250		8,329		6,338
Net income	$	77,543	$	36,812	$	134,766	$	80,546
Earnings per share – common stock, basic	$	1.04	$	1.01	$	2.01	$	2.21
Earnings per share – common stock, diluted	$	1.04	$	1.01	$	2.01	$	2.21
Dividends per share	$	1.00	$	1.10	$	2.00	$	2.30
Weighted average shares outstanding		74,807,174		36,609,290		67,167,275		36,426,572

See accompanying notes.

3

Hatteras Financial Corp.

Statement of Changes in Shareholders’ Equity

For the six months ended June 30, 2011

(Unaudited)

(Dollars in thousands)	Common Stock Amount		Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance at December 31, 2010	$	46	$	1,043,027	$	(3,480	)	$	105,891		$	1,145,484
Issuance of common stock		29		817,707		—			—			817,736
Share based compensation		—		401		—			—			401
Dividends declared on common stock		—		—		(133,163	)		—			(133,163	)
Comprehensive income:
Net income		—		—		134,766			—			134,766
Other comprehensive income:
Net unrealized gain on securities available for sale		—		—		—			96,950			96,950
Net unrealized loss on derivative instruments		—		—		—			(55,568	)		(55,568	)
Comprehensive income												176,148
Balance at June 30, 2011	$	75	$	1,861,135	$	(1,877	)	$	147,273		$	2,006,606

See accompanying notes.

4

Hatteras Financial Corp.

Statements of Cash Flows

(Unaudited)

(Dollars in thousands)	For the six months ended June 30, 2011			For the six months ended June 30, 2010
Operating activities
Net income	$	134,766		$	80,546
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premium related to mortgage-backed securities		30,610			20,534
Amortization related to interest rate swap agreements		151			110
Share based compensation expense		401			690
Hedge ineffectiveness		386			261
Gain on sale of mortgage-backed securities		(4,405	)		(1,044	)
Changes in operating assets and liabilities:
(Increase) decrease in accrued interest receivable		(22,529	)		4,055
Increase in other assets		(1,200	)		(4,299	)
Decrease in accrued interest payable		(606	)		(475	)
Increase (decrease) in accounts payable and other liabilities		125			(687	)
Net cash provided by operating activities		137,699			99,691
Investing activities
Purchases of mortgage-backed securities		(8,394,241	)		(1,137,688	)
Principal repayments of mortgage-backed securities		1,267,891			1,323,000
Sale of mortgage-backed securities		360,203			30,529
Net cash (used in) provided by investing activities		(6,766,147	)		215,841
Financing activities
Issuance of common stock, net of cost of issuance		817,736			32,974
Cash dividends paid		(104,188	)		(87,206	)
Increase in restricted cash		(84,047	)		(33,653	)
Proceeds from repurchase agreements		72,246,435			35,332,262
Principal repayments on repurchase agreements		(66,126,901	)		(35,695,782	)
Net cash provided by (used in) financing activities		6,749,035			(451,405	)
Net increase (decrease) in cash and cash equivalents		120,587			(135,873	)
Cash and cash equivalents, beginning of period		112,626			225,828
Cash and cash equivalents, end of period	$	233,213		$	89,955
Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	62,709		$	47,593
Supplemental schedule of non-cash financing activities
Obligation to brokers incurred for purchase of mortgage-backed securities	$	260,415		$	850,634

See accompanying notes.

5

Hatteras Financial Corp.

Notes to Financial Statements

June 30, 2011

(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 the Government National Mortgage Association (“Ginnie Mae”), the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (“Agency MBS”). The Company is externally managed by Atlantic Capital Advisors, LLC (“ACA”).

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, 2011 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2011. 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, 2010.

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 MBS and derivative instruments.

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 approximate their fair value due to the short maturities of these instruments. See Note 4 for discussion of the fair value of MBS 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.

Since inception through June 30, 2011, the Company has 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 Note 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.

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 Agency 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 at least 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 (“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.

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 $194 and $347 for the three months ended June 30, 2011 and 2010, respectively. The Company’s share-based compensation transactions resulted in compensation expense of $401 and $690 for the six months ended June 30, 2011 and 2010, 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 using the two class method, as described in the ASC Topic on Earnings Per Share, which takes into account certain adjustments related to participating securities. Net income available to holders of common stock after deducting dividends on unvested participating securities if antidilutive, is divided 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 April 2011, the FASB issued an Accounting Standard Update, (“ASU”) ASU 2011-03,Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreementsregarding repurchase agreements. In a typical repurchase agreement transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Prior to this update, one of the factors in determining whether sale treatment could be used was whether the transferor maintained effective control of the transferred assets by having the ability to repurchase such assets. Based on this update, the FASB concluded that the assessment of effective control should focus on a transferor’s contractual rights and obligations with respect to transferred financial assets, rather than whether the transferor has the practical ability to perform in accordance with those rights or obligations. Therefore, this update removes the transferor’s ability criterion from consideration of effective control. This update is effective for the first interim or annual period beginning on or after December 15, 2011 and is not expected to have a material effect on the Company’s financial statements.

In May 2011, the FASB issued ASU 2011-04,Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.ASU 2011-04 changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between GAAP and International Financial Reporting Standards (IFRS). ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This update is effective for the first interim or annual period beginning on or after December 15, 2011 and is not expected to have a material effect on the Company’s financial statements.

In June 2011, the FASB issued ASU 2011-05,Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This update is effective for the first interim or annual period beginning on or after December 15, 2011 and is not expected to have a material effect on the Company’s financial statements.

3. Financial Instruments

The Company’s valuation techniques for 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.

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

	June 30, 2011
	Fair Value Measurements Using						Total at
	Level 1		Level 2		Level 3		Fair Value
Assets
Mortgage backed securities	$	—	$	16,416,897	$	—	$	16,416,897
Unsettled purchased mortgage backed securities		—		23,995		—		23,995
Interest rate hedges		—		4,137				4,137
Forward purchase commitments*		—		1,227				1,227
Total	$	—	$	16,446,256	$	—	$	16,446,256
Liabilities
Interest rate hedges	$	—	$	117,536	$	—	$	117,536
Forward purchase commitments*		—		65		—		65
Total	$	—	$	117,601	$	—	$	117,601

* Located in other assets and other liabilities on the balance sheet.

The carrying values and approximate fair values of all financial instruments as of June 30, 2011 and December 31, 2010 were as follows:

	June 30, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Mortgage backed securities	$	16,416,897	$	16,416,897	$	9,587,216	$	9,587,216
Unsettled purchased mortgage backed securities		23,995		23,995		49,710		49,710
Cash and cash equivalents		233,213		233,213		112,626		112,626
Restricted cash		159,469		159,469		75,422		75,422
Accrued interest receivable		60,502		60,502		37,973		37,973
Debt Security		15,000		15,000		15,000		15,000
Interest rate hedge asset		4,137		4,137		23,944		23,944
Forward purchase commitments		1,227		1,227		—		—
Short term investment*		20,158		20,158		19,943		19,943
Liabilities
Repurchase agreements	$	14,800,594	$	14,800,594	$	8,681,060	$	8,681,060
Payable for unsettled securities		23,958		23,958		49,774		49,774
Accrued interest payable		2,571		2,571		3,177		3,177
Interest rate hedge liability		117,536		117,536		71,681		71,681
Forward purchase commitments		65		65		8,545		8,545

* This line item is included in other assets and other liabilities on the balance sheet.

4. Mortgage-Backed Securities

All of the Company’s Agency MBS were classified as available-for-sale and, as such, are reported at their estimated fair value. The Agency MBS market is primarily an over-the-counter market. As such, there are no standard, public market quotations or published trading data for individual Agency MBS. The fair values of the Company’s Agency MBS are generally determined by management by obtaining valuations for each agency security from at least three separate and independent sources and averaging the valuations. These sources include MBS pricing services and MBS traders at broker-dealers.

Traders at broker-dealers function as market makers for these securities and these brokers have the most complete view of the trading activity. Brokers do not receive compensation for providing pricing information to the Company. The prices received are non-binding offers to trade, but are indicative quotations of the market value of the Company’s securities as of the market close of the last day of each quarter. The brokers receive trading data from several traders that participate in the active markets for these securities and directly observe numerous trades of securities similar to the securities owned by the Company. Given the volume of market activity for Agency MBS, it is the Company’s belief that the broker pricing accurately reflects market information for actual, contemporaneous transactions based on the Company’s review and analysis of the quotes or prices from the independent sources. The Company’s analysis also includes an evaluation of the spread between the quotes or prices. The Company does not adjust quotes or prices it obtains from brokers and pricing services.

If the fair value of a security is not available from a dealer or third-party pricing service or such data appears unreliable, the Company may estimate the fair value of the security using a variety of methods including, but not limited to, other independent pricing services, repurchase agreement pricing, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors. At June 30, 2011, all of the Company’s Agency MBS values were based on third-party sources.

To validate the prices the Company obtains, to ensure the Company’s fair value determinations are consistent with the ASC Topic on Fair Value Measurements and Disclosures, and to ensure that the Company properly classifies its assets and liabilities in the fair value hierarchy, the Company evaluates the pricing information it receives taking into account factors such as coupon, prepayment experience, fixed/adjustable rate, coupon index, time to next reset and issuing agency, among other factors.

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, 2011.

	MBS Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency MBS
Fannie Mae Certificates	$	11,466,783	$	(5,526	)	$	200,270	$	11,661,527
Freddie Mac Certificates		4,690,946		(4,771	)		69,195		4,755,370
Total MBS	$	16,157,729	$	(10,297	)	$	269,465	$	16,416,897

The following table presents certain information about the Company’s MBS at December 31, 2010.

	MBS Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency MBS
Fannie Mae Certificates	$	6,537,472	$	(18,342	)	$	138,626	$	6,657,756
Freddie Mac Certificates		2,887,432		(14,783	)		56,811		2,929,460
Total MBS	$	9,424,904	$	(33,125	)	$	195,437	$	9,587,216

The components of the carrying value of available-for-sale MBS at June 30, 2011 and December 31, 2010 are presented below.

	June 30, 2011			December 31, 2010
Principal balance	$	15,780,983		$	9,228,093
Unamortized premium		376,755			196,823
Unamortized discount		(9	)		(12	)
Gross unrealized gains		269,465			195,437
Gross unrealized losses		(10,297	)		(33,125	)
Carrying value/estimated fair value	$	16,416,897		$	9,587,216

The Company monitors the performance and market value of its Agency MBS portfolio on an ongoing basis. At June 30, 2011 and December 31, 2010, the Company had the following securities in a loss position presented below:

	Less than 12 months as of June 30, 2011					Less than 12 months as of December 31, 2010
	Fair Market Value		Unrealized Loss			Fair Market Value		Unrealized Loss
Fannie Mae Certificates	$	1,112,567	$	(5,526	)		1,641,355		(18,342	)
Freddie Mac Certificates		1,131,560		(4,771	)		1,186,443		(14,783	)
Total temporarily impaired securities	$	2,244,127	$	(10,297	)		2,827,798		(33,125	)

The Company did not make the decision to sell the above securities as of June 30, 2011, 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 Agency MBS portfolio for the three and six months ended June 30, 2011 and 2010:

	Three Months Ended						Six Months Ended
	June 30, 2011			June 30, 2010			June 30, 2011			June 30, 2010
Coupon interest on MBS	$	130,943		$	74,761		$	230,733		$	152,915
Net premium amortization		(17,755	)		(11,320	)		(30,610	)		(20,533	)
Interest income on MBS, net	$	113,188		$	63,441		$	200,123		$	132,382

The contractual maturity of the Company’s Agency MBS ranges from 20 to 30 years. Because of prepayments on the underlying mortgage loans, the actual weighted-average maturity is expected to be significantly less than the stated maturity. The following table presents certain information about the Company’s Agency MBS that will reprice or amortize based on contractual terms, which do not consider prepayment assumptions at June 30, 2011 and December 31, 2010:

	June 30, 2011								December 31, 2010
	Fair Value		% of Total			Weighted Average Coupon			Fair Value		% of Total			Weighted Average Coupon
Months to Coupon Reset or Contractual Payment
0 - 18 Months	$	1,003,150		6.0	%		4.31	%	$	632,979		6.6	%		3.80	%
19 - 36 Months		1,157,422		7.1	%		4.75	%		1,628,967		17.0	%		5.15	%
37 - 60 Months		9,136,269		55.7	%		3.47	%		5,195,156		54.2	%		3.78	%
61 - 84 Months		4,944,690		30.1	%		3.45	%		1,938,935		20.2	%		3.46	%
85 - 120 Months		175,366		1.1	%		3.98	%		191,180		2.0	%		3.56	%
Total MBS	$	16,416,897		100.0	%		3.61	%	$	9,587,216		100.0	%		3.94	%

Unsettled Agency MBS Purchases

While most of the Company’s purchases of Agency MBS are accounted for using trade date accounting, some forward purchases, such as certain TBA’s do not qualify for trade date accounting and are considered derivatives for financial statement purposes. Pursuant to ASC Topic 815, the Company accounts for these derivatives as all-in-one cash flow hedges. The net fair value of the forward commitment is reported on the balance sheet as an asset (or liability), with a corresponding unrealized gain (or loss) recognized in other comprehensive income. The following table shows the Agency MBS forward purchase commitments shown as a net liability on the balance sheet as of June 30, 2011.

Face		Cost		Fair Market Value		Due to Brokers (1)		Net Liability
$	230,000	$	236,457	$	236,392	$	236,457	$	(65	)

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

Since the Company purchases forward for the purposes of holding the securities for investment, the Company considers all its Agency MBS, settled or unsettled, as part of its portfolio for the purposes of cash flow and interest rate sensitivity, and consequently hedging, duration measurement, and other related investment management activity.

5. Debt Security, Held to Maturity

The Company acquired a $15,000 debt security from a repurchase lending counterparty that matures May 10, 2012. The debt security bears interest at the rate of 4.5% above the three-month LIBOR rate. The Company estimates the fair value of this note to approximate amortized cost based on the prices of other 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, 2011 and December 31, 2010, the Company had repurchase agreements in place in the amount of $14,800,594 and $8,681,060, respectively, to finance Agency MBS purchases. At June 30, 2011 and December 31, 2010, the weighted average interest rate on these borrowings was 0.24% and 0.44%, respectively. The Company’s repurchase agreements are collateralized by the Company’s Agency MBS and typically bear interest at rates that are based on LIBOR. At June 30, 2011 and December 31, 2010, the Company had repurchase agreements outstanding with 23 and 20 counterparties, respectively, with a weighted average contractual maturity of 0.8 months and 0.9 months, respectively. The following table presents the contractual repricing information regarding the Company’s repurchase agreements:

	June 30,2011					December 31, 2010
	Balance		Weighted Average Contractual Rate			Balance		Weighted Average Contractual Rate
Within 30 days	$	14,800,594		0.24	%	$	7,530,317		0.38	%
30 days to 3 months		—		—			1,050,743		0.60	%
3 months to 36 months		—		—			100,000		2.96	%
	$	14,800,594		0.24	%	$	8,681,060		0.44	%

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 agreement changes on a monthly basis, the Company is exposed to constantly changing interest rates, and the cash flows associated with these rates. To mitigate the effect of changes in these interest rates, the Company enters into interest rate swap agreements 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 fix interest rates on a portion of the Company’s outstanding debt for the terms of the swaps.

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, 2011 and 2010, these effective hedge losses totaled $127,913 and $49,125, respectively. During the six months ended June 30, 2011 and 2010, these effective hedge losses totaled $109,687 and $78,559, respectively. Ineffective hedge losses are recorded on a current basis in earnings and for the three months ended June 30, 2011 and 2010, the Company recorded $241 and $48, respectively. For the six months ending June 30, 2011 and 2010 the Company recorded $385 and $261, respectively, of hedge ineffectiveness 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 $107,368 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 38 months. The table below shows the remaining term of the Company’s interest rate swaps as of June 30, 2011.

Maturity	Notional Amount			Remaining Term in Months		Weighted Average Fixed  Interest Rate in Contract
12 months or less	$	300,000			4		3.45	%
Over 12 months to 24 months		800,000			18		1.90	%
Over 24 months to 36 months		1,200,000			31		1.90	%
Over 36 months to 48 months		3,800,000			43		1.78	%
Over 48 months to 60 months		1,300,000			51		1.65	%
Total	$	7,400,000	weighted average		38		1.86	%

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 sheets as of June 30, 2011 and December 31, 2010, respectively.

	Asset Derivatives							Liability Derivatives
	As of June 30, 2011			As of December 31, 2010				As of June 30, 2011			As of December 31, 2010
	Balance Sheet	Fair Value		Balance Sheet		Fair Value		Balance Sheet	Fair Value		Balance Sheet		Fair Value
Interest rate hedge	Interest rate hedge asset	$	4,137		Interest rate hedge asset	$	23,944	Interest rate hedge liability	$	117,536		Interest rate hedge liability	$	71,681
Forward purchase commitment	Other assets	$	1,227		—	$	—	Account payable and other liabilities	$	65		—	$	8,545

The table below presents the effect of the Company’s derivative financial instruments on the income statement for the three months ended June 30, 2011.

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	$	127,913	Interest Expense	$	26,939	Interest Expense	$	241

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 six months ended June 30, 2011.

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	$	109,687	Interest Expense	$	44,412	Interest Expense	$	385

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

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, 2011 and the year ended December 31, 2010, respectively.

	June 30, 2011			December 31, 2010
Beginning balance	$	(47,676	)	$	(35,742	)
Unrealized loss on interest rate swaps		(109,687	)		(80,351	)
Reclassification of net losses included in income statement		44,412			68,417
Ending balance	$	(112,951	)	$	(47,676	)

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.

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, 2011, the fair value of derivatives in a net liability position related to these agreements was $113,399. The Company has collateral posting requirements with each of its counterparties and all interest rate swap agreements were fully collateralized as of June 30, 2011. At June 30, 2011 the Company was in compliance with these requirements.

8. Capital Stock

Issuance of Common Stock – CEO Program

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 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 through a market maker other than on an exchange. For the three months ended June 30, 2011, the Company issued 345,000 shares of common stock in at-the-market transactions, raising net proceeds to the Company, after sales commissions and fees, of $9,930. For the six months ended June 30, 2011, the Company issued 795,000 shares of common stock in at-the-market transactions, raising net proceeds to the Company, after sales commissions and fees, of $23,334. The total commissions and fees charged to additional paid in capital in connection with the issuance of these shares were $135 and $370, respectively, for the three and six months ended June 30, 2011. 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, 2011		June 30, 2010		June 30, 2011		June 30, 2010
Basic earnings per share:
Net income		$	77,543	$	36,812	$	134,766	$	80,546
Weighted average shares			74,807,174		36,609,290		67,167,275		36,426,572
Basic earnings per share		$	1.04	$	1.01	$	2.01	$	2.21
	��
Diluted earnings per share:
Net income		$	77,543	$	36,812	$	134,766	$	80,546
Weighted average shares			74,807,174		36,609,290		67,167,275		36,426,572
Potential dilutive shares from exercise of stock options			—		20,295		—		20,590
Diluted weighted average shares			74,807,174		36,629,585		67,167,275		36,447,162
Diluted earnings per share		$	1.04	$	1.01	$	2.01	$	2.21

10. Transactions with Related Parties

Management Fees

The Company is externally managed by 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, 2011 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 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 various overhead 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, 2011 and 2010, the Company incurred $3,531 and $2,196 in management fees, respectively. For the six months ended June 30, 2011 and 2010, the Company incurred $6,623 and $4,379 in management fees, respectively At June 30, 2011 and December 31, 2010, the Company owed ACA $1,171 and $828, 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, 2011			December 31, 2010
Unrealized gain on agency securities, net		259,168		$	162,312
Unrealized loss on unsettled securities		37			(64	)
Unrealized loss on short term investment*		(143	)		(136	)
Unrealized loss on derivative instruments		(111,789	)		(56,221	)
Accumulated other comprehensive income		147,273			105,891

* This line item is included in Other Assets on the Balance Sheet.

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, 2011 and 2010 consists of the following components:

	Three months ended						Six months ended
	June 30, 2011			June 30, 2010			June 30, 2011			June 30, 2010
Net Income	$	77,543		$	36,812		$	134,766		$	80,546
Unrealized gain on securities		135,701			38,881			96,950			40,794
Unrealized loss on derivative instruments		(97,301	)		(24,824	)		(55,568	)		(36,205	)
Comprehensive income	$	115,943		$	50,869		$	176,148		$	85,135

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: “MBS” refers to mortgage-backed securities; “Agency MBS” and “agency securities” refer to our residential MBS that are issued or guaranteed by a U.S. Government sponsored entity, such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. Government, such as the Government National Mortgage Association (“Ginnie Mae”); “ARMs” refer to adjustable-rate mortgage loans which typically either 1) at all times have interest rates that adjust periodically to an increment over a specified interest rate index; or 2) 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.

The following discussion should be read in conjunction with our financial statements and accompanying notes included in Part 1, 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, 2010, filed with the Securities and Exchange Commission (“SEC”) on February 18, 2011.

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 our investment financing and hedging strategy; the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity requirements; the liquidity of our portfolio; unanticipated changes in our industry, the credit markets, the general economy or the real estate market; 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 real estate investment trust (“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 our annual report on Form 10-K for the year ended December 31, 2010, including those set forth under the section captioned “Risk Factors” in our 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 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 an externally-managed mortgage REIT that invests primarily in single-family residential mortgage pass-through securities guaranteed or issued by a U.S. Government agency (such as the Ginnie Mae), or by a U.S. Government-sponsored entity (such as the Fannie Mae and Freddie Mac). We refer to these securities as “agency securities.” We were incorporated in Maryland in September 2007 and commenced operations in November 2007. Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “HTS.”

We are externally-managed and advised by our manager, Atlantic Capital Advisors LLC.

We are organized and conduct our operations to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), and generally are not subject to federal taxes on our income to the extent we distribute our income to our shareholders and maintain our qualification as a REIT.

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 any 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 techniques, 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 swap options to protect against adverse interest rate movements.

We focus on agency securities consisting of 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.

Our manager’s approach to managing our portfolio is to take a longer term view of assets and liabilities; accordingly, our periodic earnings and mark-to-market valuations at the end of a period will not significantly influence our strategy of providing stable cash distributions to shareholders over the long term. Our manager has invested and seeks to invest in agency securities that it believes are likely to generate attractive risk-adjusted returns on capital invested, after considering (1) the amount and nature of anticipated cash flows from the asset, (2) our ability to borrow against the asset, (3) the capital requirements resulting from the purchase and financing of the asset, and (4) the costs of financing, hedging, and managing the asset.

Our focus on asset selection is to own assets with short duration and predictable prepayment characteristics. Since our formation, all of our invested assets have been in agency securities, and we currently intend that our investment assets will continue to be agency securities. These agency securities currently consist of whole-pool, pass-through certificates that are backed by ARMs that have principal and interest payments guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac. ARMs are mortgages that have floating interest rates that reset on a specific time schedule, such as monthly, quarterly or annually, based on a specified index, such as the 12-month moving average of the one-year constant maturity U.S. Treasury rate (“CMT) or the London Interbank Offered Rate (“LIBOR”). The ARMs we generally invest in, sometimes referred to as hybrid ARMS, have interest rates that are fixed for an initial period (typically three, five, seven or 10 years) and then reset annually thereafter to an increment over a pre-determined interest rate index. As of June 30, 2011, our portfolio consisted of approximately $16.7 billion in market value of Agency MBS with a weighted average initial fixed-interest rate period of 56 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.

The following table represents key data regarding our company since January 1, 2009:

(in thousands except per share amounts)

As of	Agency MBS (1)		Repurchase Agreements		Equity		Shares Outstanding		Book Value Per Share		Quarterly Weighted Average Earnings Per Share
June 30, 2011	$	16,678,511	$	14,800,594	$	2,006,606		75,092	$	26.72	$	1.04
March 31, 2011	$	14,811,137	$	11,495,749	$	1,894,540		72,572	$	26.11	$	0.96
December 31, 2010	$	10,418,764	$	8,681,060	$	1,145,484		46,116	$	24.84	$	0.99
September 30, 2010	$	9,581,916	$	6,678,426	$	1,190,313		46,085	$	25.83	$	1.12
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

(1) Includes gross unsettled purchases and forward commitments to purchase agency MBS.

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, 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,

government actions, 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 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. The current climate of government intervention in the mortgage markets significantly increases the risk associated with prepayments.

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;

• changes in the credit ratings of the securities in our portfolio; 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 the section captioned “Risk Factors” in Part II, Item 1A of this Form 10-Q, and in our Annual Report on Form 10-K for the year ended December 31, 2010.

Market and Interest Rate Trends and the Effect on our Portfolio

Credit Market Disruption

Since 2007, 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 residential MBS, including agency securities. While these

markets have recovered a great deal, further increased volatility and deterioration in the broader residential mortgage and residential MBS 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. If volatile market conditions returned, our lenders may be forced to exit the repurchase market, 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.

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 have 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 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 at the time generally increased credit spreads and decreased price stability of agency securities. In response to the credit market disruption and the deteriorating financial condition of Fannie Mae and Freddie Mac, Congress and the U.S. Department of the Treasury (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 2011, the U.S. Treasury along with the U.S. Department of Housing and Urban Development released a report entitled “Reforming America’s Housing Finance Market” to congress outlining recommendations for reforming the U.S. housing system, specifically Fannie Mae and Freddie Mac and transforming the government’s involvement in the housing market. It is unclear how future legislation may impact the housing finance market and the investing environment for agency securities as the method of reform is undecided and has not yet been defined by the regulators. Without government support for residential mortgages, we may not be able to execute our current business model in an efficient manner.

U.S. Treasury Market Intervention

One of the main factors impacting market prices has been the U.S. Federal Reserve System’s (the “U.S. Federal Reserve”) programs to purchase Treasury and agency securities in the open market. The most significant of these programs commenced in January 2009 and was terminated on March 31, 2010. In total, $1.25 trillion of agency securities was purchased. Beginning in November 2010, the U.S. Federal Reserve announced another program to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.

An effect of these purchases has been an increase in the prices of agency securities, which has decreased our net interest margin. When these programs terminated, the market expectation was that it might cause a decrease in demand for these securities which would likely reduce their market price. However, this generally has not happened and we continue to see strong demand as these securities remain desirable assets in this rather volatile economic environment. It is difficult to quantify the impact, as there are many factors at work at the same time which affects the price of our securities and, therefore, our yield and book value. Due to the unpredictability in the markets for our securities in particular and yield generating assets in general, there is no pattern that can be implied with any certainty. We believe the largest risk is that if the government decides to sell significant portions of its portfolio, then we may see meaningful price declines.

U.S Government Credit Rating

The current U.S. debt ceiling and budget deficit concerns have increased the possibility of the credit-rating agencies downgrading the U.S. government’s credit rating for the first time in history. As assets backed by Fannie Mae and Freddie Mac are considered to have the credit of the U.S. government, if the U.S. government’s credit rating was downgraded it would likely impact the credit risk associated with Agency MBS and, therefore, decrease the value of the Agency RMBS in our portfolio. In addition, a downgrade of the U.S. government’s credit rating would likely create broader financial turmoil and uncertainty, which could have a serious negative impact on the global banking system. This could have an adverse impact on our business, financial condition and results of operations.

Regulatory Concerns

Certain programs initiated by the U.S. Government, through the Federal Housing Administration and the Federal Deposit Insurance Corporation (“FDIC”), to provide homeowners with assistance in avoiding residential mortgage loan foreclosures are currently in effect. The programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans. While the effect of these programs has not been as extensive as originally expected, the effect of such programs for holders of agency securities could be that such holders would experience changes in the anticipated yields of their agency securities due to (i) increased prepayment rates and (ii) lower interest and principal payments.

On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act is extensive, complicated and comprehensive legislation that impacts practically all aspects of banking, and a significant overhaul of many aspects of the regulation of the financial services industry. Although many provisions remain subject to further rulemaking, the Dodd-Frank Act implements numerous and far-reaching changes that affect financial companies, including our Company, and other banks and institutions which are important to our business model. Certain notable rules are, among other things:

• Requiring regulation and oversight of large, systemically important financial institutions by establishing an interagency council on systemic risk and implementation of heightened prudential standards and regulation by the Board of Governors of the U.S. Federal Reserve for systemically important financial institutions (including nonbank financial companies), as well as the implementation of the FDIC resolution procedures for liquidation of large financial companies to avoid market disruption;

• applying the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies, savings and loan holding companies and systemically important nonbank financial companies;

• limiting the U.S. Federal Reserve’s emergency authority to lend to nondepository institutions to facilities with broad-based eligibility, and authorizing the FDIC to establish an emergency financial stabilization fund for solvent depository institutions and their holding companies, subject to the approval of Congress, the Secretary of the U.S. Treasury and the U.S. Federal Reserve;

• creating regimes for regulation of over-the-counter derivatives and non-admitted property and casualty insurers and reinsurers;

• implementing regulation of hedge fund and private equity advisers by requiring such advisers to register with the SEC;

• providing for the implementation of corporate governance provisions for all public companies concerning proxy access and executive compensation; and

• reforming regulation of credit rating agencies.

Many of the provisions of the Dodd-Frank Act, including certain provisions described above are subject to further study, rulemaking, and the discretion of regulatory bodies. As the hundreds of regulations called for by the Dodd-Frank Act are promulgated, we will continue to evaluate the impact of any such regulations. It is unclear how this legislation may impact the borrowing environment, investing environment for agency securities and interest rate swaps as much of the bill’s implementation has not yet been defined by the regulators.

In addition, in 2010, the Group of Governors and Heads of Supervisors of the Basel Committee on Banking Supervision, the oversight body of the Basel Committee, published its “calibrated” capital standards for major banking institutions (“Basel III”). Under these standards, when fully phased in on January 1, 2019, banking institutions will be required to maintain heightened Tier 1 common equity, Tier 1 capital and total capital ratios, as well as maintaining a “capital conservation buffer.” Beginning with the Tier 1 common equity and Tier 1 capital ratio requirements, Basel III will be phased in incrementally between January 1, 2013 and January 1, 2019. The final package of Basel III reforms were approved by the G20 leaders in November 2010 and are subject to individual adoption by member nations, including the United States by January 1, 2013. It is unclear how the adoption of Basel III will affect our business at this time.

Interest 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. Significant volatility in these rates or a 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. For example, even though 30-day LIBOR was 0.26% at December 31, 2010, our 30-day borrowing costs associated with our repurchase agreements moved up to an average of 0.38% due to market volatility. 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, 2011		0.19	%		0.25	%
March 31, 2011		0.24	%		0.25	%
December 31, 2010		0.26	%		0.25	%
September 30, 2010		0.26	%		0.25	%
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	%

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 item 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 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, 2011		4.64	%		18.54	%
March 31, 2011		5.61	%		22.44	%
December 31, 2010		7.81	%		31.26	%
September 30, 2010		8.48	%		33.91	%
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	%

Investing the Proceeds of our Offerings

Due to the restrictions requiring the distribution of REIT income, our ability to grow the company is based on raising additional equity capital. We began operations following the consummation of our initial private offering on November 5, 2007. We raised additional private equity again in February 2008 and completed our initial public offering in April 2008. We have completed four follow-on offering transactions since that time. The following is a summary of these transactions:

(Dollars in thousands except per share amounts)

Date of Offering	Number of Shares of Common Stock Sold		Offering Price Per Share		Net Proceeds (1)
November 5, 2007		8,203,937	$	20.00	$	157,054
February 5, 2008		6,900,000	$	24.00	$	158,743
April 30, 2008 (IPO)		11,500,000	$	24.00	$	255,440
December 15, 2008		9,409,090	$	22.00	$	196,463
September 21, 2010		7,475,000	$	28.75	$	205,642
January 5, 2011		11,500,000	$	28.75	$	325,707
March 18, 2011		16,675,000	$	28.50	$	468,765

(1) After deducting underwriting costs and other fees and costs associates with issuance.

While our operations are affected in many ways by the issuance of additional shares, the most significant immediate earnings impact is that we generally do not invest all of the proceeds immediately. Depending on market conditions, and considering the fact that normal trade settlement on agency securities is not based on the trade date, on average, we have invested the proceeds from these offerings in approximately two months from the date of these offering. Since each capital raise was individually significant to the size of our portfolio, our results from operations, and some statistics regarding such results, may not be meaningful or portray the underlying fundamentals of our investment portfolio.

Book Value per Share

As of June 30, 2011, our book value per share of common stock (total shareholders’ equity divided by shares of common stock outstanding) was $26.72, an increase of $1.88, from $24.84 at December 31, 2010. This increase can be attributed to our common equity offerings during the first six months of 2011 all of which were done at prices which were accretive to our then current book value per share. The unrealized gain per share on our MBS was up slightly, while the unrealized loss per share on our interest rate swaps increased. Although we attempt to structure our interest rate swap portfolio to offset the changes in asset prices, they are not perfectly correlated, and depend on the corresponding durations and section of the yield curve that moves to offset each other. Also, there are other factors, such as credit perceptions, which may affect these values so at times they may move in the same direction. The following table shows the components of our book value on a per share basis at each period end:

As of	Common Equity		Undistributed Earnings			Unrealized Gain/(Loss) on MBS		Unrealized Gain/(Loss) on Interest Rate Swaps			Book Value Per Share
June 30, 2011	$	24.79		(0.03	)		3.47		(1.51	)	$	26.72
March 31, 2011	$	24.67		(0.06	)		1.67		(0.17	)	$	26.11
December 31, 2010	$	22.62		(0.08	)		3.33		(1.03	)	$	24.84
September 30, 2010	$	22.63		(0.07	)		5.66		(2.39	)	$	25.83
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

Investments

Agency Securities

As of June 30, 2011 and December 31, 2010, our agency securities portfolio was purchased at a net premium to par, or face value, with a weighted-average amortized cost of 102.39 and 102.13, respectively, of face value. As of June 30, 2011 and December 31, 2010, we had approximately $376.7 million and $196.8 million, respectively, of unamortized premium included in the cost basis of our investments.

As of June 30, 2011, our investment portfolio consisted of adjustable-rate agency securities as follows:

(dollars in thousands)	% of			Current		Weighted Avg.			Weighted Avg. Amortized				Weighted Avg.
Months to Reset	Portfolio			Face value (1)		Coupon (2)			Purchase Price (3)		Amortized Cost (4)		Market Price (5)		Market Value (6)
0-18		6.0	%	$	948,735		4.31	%	$	101.37	$	961,749	$	105.74	$	1,003,150
19-36		7.1	%		1,088,054		4.75	%	$	101.33		1,102,534	$	106.38		1,157,422
37-60		55.7	%		8,781,342		3.47	%	$	102.49		9,000,282	$	104.04		9,136,269
61-84		30.1	%		4,793,781		3.45	%	$	102.59		4,918,017	$	103.15		4,944,690
85-120		1.1	%		169,072		3.98	%	$	103.59		175,147	$	103.72		175,366
Total MBS		100.0	%	$	15,780,984		3.61	%	$	102.39	$	16,157,729	$	104.03	$	16,416,897

As of December 31, 2010, our investment portfolio consisted of adjustable-rate agency securities as follows:

(dollars in thousands)	% of			Current		Weighted Avg.			Weighted Avg. Amortized				Weighted Avg.
Months to Reset	Portfolio			Face value (1)		Coupon (2)			Purchase Price (3)		Amortized Cost (4)		Market Price (5)		Market Value (6)
0-18		6.6	%	$	605,242		3.80	%	$	101.54	$	614,569	$	104.58	$	632,978
19-36		17.0	%		1,535,856		5.15	%	$	101.29		1,555,726	$	106.06		1,628,967
37-60		54.2	%		5,001,576		3.78	%	$	102.13		5,107,959	$	103.87		5,195,156
61-84		20.2	%		1,897,287		3.46	%	$	102.88		1,951,899	$	102.20		1,938,935
85-120		2.0	%		188,132		3.56	%	$	103.52		194,751	$	101.62		191,180
Total MBS		100.0	%	$	9,228,093		3.94	%	$	102.13	$	9,424,904	$	103.89	$	9,587,216

⁽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, 2011 and December 31, 2010:

	June 30, 2011					December 31, 2010
(dollars in thousands)	Estimated Fair Value		% of Total			Estimated Fair Value		% of Total
Agency MBS
Fannie Mae Certificates	$	11,661,527		71.0	%	$	6,657,756		69.4	%
Freddie Mac Certificates		4,755,370		29.0	%		2,929,460		30.6	%
Total MBS	$	16,416,897				$	9,587,216

We typically want to own a higher percentage of Fannie Mae MBS than Freddie Mac MBS as Fannie Mae has better cash flow to the security holder because it pays the principal and interest quicker after accrual (45 days) as compared to Freddie Mac (75 days).

As of June 30, 2011 and December 31, 2010, the ARMs underlying our agency securities had fixed interest rates for an average period of approximately 56 and 53 months, respectively, after which time the interest rates reset and become adjustable annually. At June 30, 2011, 97.6% of our Agency MBS were still in their initial fixed-rate period, and approximately 0.6% of our Agency MBS will reach the end of their initial fixed-rate period in the next 12 months. The balance, 1.8% of our Agency MBS, have already reached their initial reset period and will reset annually for the life of the security.

After the reset date, interest rates on our agency ARMs float based on spreads over various indices, usually LIBOR or the one-year CMT. These interest rate adjustments are subject to caps that limit the amount the applicable interest rate can increase during any year, known as an annual cap, and through the maturity of the security, known as a lifetime cap. Our agency ARMs typically have a maximum initial one-time adjustment of 5%, and the average annual interest rate increase (or decrease) to the interest rates on our agency securities is 2% per year. The average lifetime cap on increases (or decreases) to the interest rates on our agency securities is 5% from the initial stated rate.

While most of our purchases of Agency MBS are accounted for using trade date accounting, some forward purchases, such as certain to-be-announced securities (“TBAs”) do not qualify for trade date accounting and are considered derivatives for financial statement purposes. Pursuant to ASC Topic 815, we account for these derivatives as all-in-one cash flow hedges. The net fair value of the forward commitment is reported on the balance sheet as an asset (or liability), with a corresponding unrealized gain (or loss) recognized in other comprehensive income. Since we purchase MBS forward for the purposes of holding the securities for investment, we consider all our Agency MBS, settled or unsettled, as part of our portfolio for the purposes of cash flow and interest rate sensitivity, and consequently hedging, duration measurement, and other related investment management activity.

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, 2011 and December 31, 2010, we had established 28 and 26 borrowing relationships, respectively, with various banking firms and other lenders. We had outstanding balances under our repurchase agreements at June 30, 2011 and December 31, 2010 of $14.8 billion and $8.7 billion, respectively.

Hedging Instruments

We generally intend to hedge as much of our interest rate risk as our manager deems prudent in light of market conditions. No assurance can be given that our hedging activities will have the desired beneficial 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, 2011, we had in place 69 interest rate swap agreements designed to lock in funding costs for specific funding activities associated with specific assets, in an effort to assure realizing attractive net interest margins. Such hedge selection incorporates an assumed prepayment schedule, which, if not realized, will cause our operating 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 $7.4 billion of borrowings under our repurchase agreements.

Summary Financial Data

(in thousands, except per share amounts)

	Three months ended (unaudited)						Six months ended (unaudited)
	June 30, 2011			June 30, 2010			June 30, 2011			June 30, 2010
Statement of Income Data
Interest income on mortgage-backed securities	$	113,188		$	63,441		$	200,123		$	132,382
Interest income on short-term cash investments		331			298			671			575
Interest Expense		(35,910	)		(23,677	)		(62,104	)		(47,117	)
Net Interest Income		77,609			40,062			138,690			85,840
Gain on sale of mortgage-backed securities		4,405			—			4,405			1,044
Operating Expenses		(4,471	)		(3,250	)		(8,329	)		(6,338	)
Net Income	$	77,543		$	36,812		$	134,766		$	80,546
Earnings per share -common stock, basic	$	1.04		$	1.01		$	2.01		$	2.21
Earnings per share -common stock, diluted	$	1.04		$	1.01		$	2.01		$	2.21
Weighted average shares outstanding		74,807,174			36,609,290			67,167,275			36,426,572
Cash dividends declared per common share	$	1.00		$	1.10		$	2.00		$	2.30
Key Portfolio Statistics
Average MBS (1)	$	14,956,852		$	6,591,086		$	12,931,303		$	6,661,653
Average Repurchase Agreements (2)	$	13,540,291		$	6,092,328		$	11,771,570		$	6,157,265
Average Equity (3)	$	2,016,013		$	942,018		$	1,758,051		$	941,969
Average Portfolio Yield (4)		3.03	%		3.85	%		3.10	%		3.97	%
Average Cost of Funds (5)		1.06	%		1.55	%		1.06	%		1.53	%
Interest Rate Spread (6)		1.97	%		2.30	%		2.04	%		2.44	%
Return on Average Equity (7)		15.39	%		15.63	%		15.33	%		17.10	%
Average Annual Portfolio Repayment Rate (8)		18.54	%		45.08	%		20.17	%		40.52	%
Debt to Equity(at period end) (9)		7.4:1			6.2:1			7.4:1			6.2:1
Debt to Additional Paid in Capitalat period end) (10)		8.0:1			7.4:1			8.0:1			7.4:1
Selected Balance Sheet Data
Mortgage-backed securities	$	16,416,897		$	6,791,701		$	16,416,897		$	6,791,701
Total Assets		17,027,689			7,120,463			17,027,689			7,120,463
Repurchase Agreements		14,800,594			5,982,998			14,800,594			5,982,998
Long Term Repurchase Agreements		—			100,000			—			100,000
Stockholder’s Equity		2,006,606			965,619			2,006,606			965,619

^*  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 MBS was calculated by dividing the sum of our daily Agency MBS investments during the period by the number of days in the period.

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

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

⁽⁴⁾  Our average portfolio yield was calculated by dividing our interest income on mortgage-backed securities, net of amortization, by our average Agency MBS.

⁽⁵⁾  Our average cost of funds was calculated by dividing our total interest expense (including hedges) by our average balance outstanding under our repurchase agreements.

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

⁽⁷⁾  Our return on average equity 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 year (scheduled and unscheduled) by our average MBS.

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

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

Results of Operations

Three months ended June 30, 2011 and 2010

Our primary source of income is the interest income we earn on our investment portfolio. Our interest income for the quarter ended June 30, 2011 was $113.5 million, as compared to $63.7 million for the quarter ended June 30, 2010. The most significant factor in this increase was the larger securities portfolio. Our average MBS for the quarter ended June 30, 2011 was $15.0 billion as compared to $6.6 billion for the quarter ended June 30, 2010. The increase in our interest income generally is not proportionate to the increase in average MBS because the coupon rate on our recent purchases will be at different rates than in the portfolio in the comparable quarter. Our weighted average coupon at June 30, 2011 was 3.61%, as compared to 4.56% at June 30, 2010. As mortgage rates rise and fall, they will increase or decrease our overall average coupon rate as we replace and/or add securities in our portfolio. The gross coupon on our MBS is a significant factor of the yield on our portfolio. Our annualized yield on average assets for the quarter ended June 30, 2011 was 3.03% as compared to 3.85% for the quarter ended June 30, 2010, reflecting the decline of overall mortgage rates on new securities purchased throughout the last year.

After coupon rate, the yield on our assets is most directly affected by the rate of repayments on our agency securities. Our annualized rate of portfolio repayment for the three months ended June 30, 2011 was 18.54%, which was significantly lower than the rate of 45.08% for the three months ended June 30, 2010. The rate for the quarter ended June 30, 2010 was elevated as compared to the current quarter primarily due to the impact of Fannie Mae and Freddie Mac repurchasing delinquent mortgages from existing MBS, which was a one-time event. Historically, when mortgage rates fall, the prepayment of the underlying mortgages has tended to increase. However, the current condition of the U.S. economy and housing market has inhibited, and may continue to inhibit, some homeowners’ ability to purchase a new home or refinance an existing mortgage, keeping prepayment rates slower than expected. To promote national housing market stability and economic growth, the U.S. Government has been significantly active in the mortgage market and their ability to influence the market poses a significant risk to the sustainability of our current earnings.

Our interest expense for the quarter ended June 30, 2011 was $35.9 million as compared to $23.7 million for the quarter ended June 30, 2010. Our average borrowings increased from $6.0 billion for the quarter ended June 30, 2010 to $14.8 billion for the quarter ended June 30, 2011, due to the increase in portfolio size. Although our borrowings increased, our total interest expense increased by a lesser amount due a lower overall cost of funds. Our annualized average cost of funds, including hedges, was 1.06% for the quarter ended June 30, 2011, as compared to 1.55% for the quarter ended June 30, 2010. The components of our cost of funds are 1) rates on our repurchase agreement, and 2) rates on our interest rate swaps. While short term borrowing rates were relatively unchanged between the periods, we had some longer term repurchase agreements and interest rate swaps with higher rates expire during the past year. Although we added to our total interest rate swap position, the lower rate environment allowed us to both decrease our average rate as well as maintain the average term of our swap positions.

Our net interest income for the quarter ended June 30, 2011 was $77.6 million, and our net interest margin, or “spread”, was 1.97%. For the quarter ended June 30, 2010 our net interest income was $40.1 million and our spread was 2.30%. This decrease in our spread was due to our decreased yield, as described above, mitigated by a lower cost of funds, as compared to a year ago. While the dollar figure is more influenced by the size of our portfolio and overall interest rate levels, we believe our spread is the more important indicator of our performance.

We occasionally sell securities as part of normal portfolio adjusting. We will selectively sell certain of our MBS when we think they are likely to underperform in the future as compared with other investment opportunities. We sold $360 million of MBS in the second quarter of 2011, realizing gains of $4.4 million. We sold no securities during the quarter ended June 30, 2010.

Our total operating expenses for the quarters ended June 30, 2011 and 2010 were $4.5 million and $3.3 million, respectively. This equates to an annualized expense ratio of 88 and 138 basis points, respectively, of average equity. While our expenses increased, the increase in our average equity, which was due to the additional equity capital raised in our offerings, decreased the ratio as compared to a year ago. The scalability of our business model means that growth in assets is not closely correlated to growth in expenses.

Our net income for the quarter ended June 30, 2011 was $77.5 million or $1.04 per weighted average share. This represents an annualized return on average equity of 15.39% for the period. For the quarter ended June 30, 2010, our net income was $36.8 million or $1.01 per weighted average share, and the annualized return on average equity was 15.63%. While many factors may affect these numbers, the increase in the per share earnings was due primarily to two factors. First, we had a lower yielding portfolio as we experienced spread compression from investing in increasingly lower coupon securities while our costs of funding decreased at a lesser pace. In addition, our equity capital offerings diluted our earnings per share as investing additional funds takes between two and three months on average.

Six months ended June 30, 2011 and 2010

In general, most of the items influencing our operating results for the six month periods ended June 30, 2011 and 2010 were similar as the items affecting the quarterly results described above. For the six month period ended June 30, 2011 we had interest income of $200.8 million compared to $133.0 million for the same period in 2010. Due to investing the proceeds of our common stock offerings, our portfolio was significantly larger during this period, as we had average earning assets of $12.9 billion for the six months ended June 30, 2011 compared to $6.7 billion for the six months ended June 30, 2010. Offsetting this increase in earning assets was a lower yield on the portfolio. Our yield dropped from 3.97% for the six months ended June 30, 2010 to 3.10% for the six months ended June 30, 2011. This was the result of buying lower coupon MBS with our offering proceeds and replacing repayments of principal on our MBS. The portfolio prepayment rate decreased on an annualized basis, from 40.52% for the first six months of 2010 to 20.17% for the same period in 2011. The Fannie Mae and Freddie Mac delinquent loan repurchase program, as mentioned above, were the primary cause of the increase in our rate of repayment in 2010.

Our interest expense for the six months ended June 30, 2011 was $62.1 million as compared to $47.1 million for the six months ended June 30, 2010. 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 2011. Our average cost of funds, including hedges, fell from 1.53% for the six months ended June 30, 2010 to 1.06% for the same period in 2011. We realized gains on sale of our MBS of $4.4 million for the six months ended June 30, 2011 as compared to $1.1 million for the six months ended June 30, 2010.

Our net interest income for the six months ended June 30, 2011 was $138.7 million, and our spread was 2.04%. For the six months ended June 30, 2010, our net interest income was $85.8 million and our spread was 2.44%. We incurred expenses for the six months ended June 30, 2011 and 2010 of $8.3 million and $6.3 million, respectively. We earned net income of $134.8 million or $2.01 per weighted average share for the six months ended June 30, 2011. For the six months ended June 30, 2010, we earned net income of $80.5 million or $2.21 per weighted average share. Our per share income for the six months ended June 30, 2011 was lower than the six months ended June 30, 2010 due to two main factors. First, we had lower spread in the first six months of 2011 due to lower overall mortgage rates. Second, we were investing the proceeds from our common stock offerings in January and March 2011. Our investment process generally takes from one to three months to complete, and therefore, we had not reached a typical run-rate of earnings until late in the period.

Contractual Obligations and Commitments

We had the following contractual obligations under repurchase agreements as of June 30, 2011 and December 31, 2010 (dollar amounts in thousands):

	June 30, 2011
			Weighted Average			Contractual		Total Contractual
(dollars in thousands)	Balance		Contractual Rate			Interest Payments		Obligation
Within 30 days	$	14,800,594		0.24	%	$	2,335	$	14,802,929
30 days to 3 months		—		—			—		—
3 months to 36 months		—		—			—		—
	$	14,800,594		0.24	%	$	2,335	$	14,802,929
	December 31, 2010
			Weighted Average			Contractual		Total Contractual
(dollars in thousands)	Balance		Contractual Rate			Interest Payments		Obligation
Within 30 days	$	7,530,317		0.38	%	$	1,758	$	7,532,075
30 days to 3 months		1,050,743		0.60	%		572		1,051,315
3 months to 36 months		100,000		2.96	%		1,660		101,660
	$	8,681,060		0.44	%	$	3,990	$	8,685,050

In addition, we had contractual commitments under interest rate swap agreements as of June 30, 2011. These agreements were for a total notional amount of $7.4 billion, had a weighted average rate of 1.86% and a weighted average term of 38 months.

Off-Balance Sheet Arrangements

As of June 30, 2011 and December 31, 2010, 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, 2011 and December 31, 2010, 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, 2011, we had uncommitted repurchase facilities with 28 lending counterparties to finance this portfolio, subject to certain conditions, and have borrowings outstanding with 23 of these counterparties.

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.

The table below sets forth the average amount of repurchase agreements outstanding during each quarter and the amount of these repurchase agreements outstanding as of the end of each quarter since January 1, 2009. The amounts at a period end can be both above and below the average amounts for the quarter. We do not manage our portfolio to have a pre-designated amount of borrowings at quarter end. These numbers will differ as we implement our portfolio management strategies and risk management strategies over changing market conditions.

(In thousands)	Average Daily Repurchase Agreements		Repurchase Agreements at Period End		Highest Daily Repurchase Balance During Quarter		Lowest Daily Repurchase Balance During Quarter
June 30, 2011	$	13,540,291	$	14,800,594	$	14,800,594	$	11,401,240
March 31, 2011		9,983,197		11,495,749		11,495,749		8,566,200
December 31, 2010		7,326,776		8,681,060		8,681,060		6,633,989
September 30, 2010		6,302,601		6,678,426		6,736,759		5,934,419
June 30, 2010		6,092,328		5,982,998		6,218,628		5,956,811
March 31, 2010		6,222,923		6,102,661		6,346,518		6,047,628
December 31, 2009		6,079,893		6,346,518		6,346,518		6,005,602
September 30, 2009		5,781,639		6,007,909		6,012,302		5,496,854
June 30, 2009		5,359,086		5,496,854		5,567,486		5,242,988
March 31, 2009		4,985,718		5,250,382		5,273,594		4,519,435

As of June 30, 2011, 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 4.4% (weighted by borrowing amount). As of December 31, 2010, our weighted average haircut was approximately 4.4%. We commonly receive margin calls from our lenders. We may receive

margin calls daily, although we typically receive them once or twice per month. We receive margin calls under our repurchase agreements for two reasons. One of these is what is known as a “factor call” which occurs each month when the new factors (amount of principal remaining on the security) are published by the issuing agency, such as Fannie Mae. The second type of margin call we may receive is a valuation margin call. Both factor and valuation margin calls occur whenever the total value of our MBS assets pledged as collateral drops beyond a threshold amount, which is usually between $100,000 and $250,000. Both of these margin calls require a dollar for dollar restoration of the margin shortfall above a certain minimum threshold. This threshold is usually between $50,000 and $150,000. The total amount of our unrestricted cash and cash equivalents, plus any unpledged securities, is available to satisfy margin calls, if necessary. As of June 30, 2011 and December 31, 2010, we had approximately $1.2 billion and $630 million, respectively in agency securities, cash and cash equivalents available to satisfy future margin calls. To date, we have maintained sufficient liquidity to meet margin calls, and we have never been unable to satisfy a margin call, although no assurance can be given that we will be able to satisfy requests from our lenders to post additional collateral in the future.

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. Our agreements for our repurchase facilities generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association (SIFMA) as to repayment, margin requirements and the segregation of all purchased securities covered by the repurchase agreement. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement that are generally required by the lender. Some of the typical terms which are included in such supplements and which supplement and amend terms contained in the standard agreement include changes to the margin maintenance requirements, purchase price maintenance requirements, the addition of a requirement that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default provisions. These provisions differ for each of our lenders.

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 MBS assets, due to news of potential security liquidations;

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

• significant disruption in financing of MBS.

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 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.

Similar to the valuation margin calls that we receive on our repurchase agreements, we also receive margin calls on our interest rate swaps when the value of a hedge position declines. This typically occurs when prevailing market rates decrease, with the severity of the decrease also dependent on the term of the hedges involved. The

amount of any margin call will be dollar for dollar, with a minimum transfer amount of between $100,000 and $250,000. Our posting of collateral with our hedge counterparties can be done in cash or securities, and is generally bilateral, which means that if the value of our interest rate hedges increases, our counterparty will post collateral with us.

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, 2011, the weighted average haircut under our repurchase facilities was approximately 4.4%, and our leverage (defined as our debt-to-shareholders equity ratio) was approximately 7.4:1.

Liquidity Sources—Capital Offerings

In addition to our repurchase borrowings, we also rely on primary securities offerings as a source of both short-term and long-term liquidity. During the second quarter of 2011, we received funds from sales of our common stock under an “at-the-market” offering program.

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 Fitzgerald & Co. (“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 months ended June 30, 2011, we issued 345,000 shares of common stock in at-the-market transactions at an average price of $29.18 per share raising net proceeds, after sales commissions and expenses, of approximately $9.9 million. We paid $0.1 million in sales commissions to Cantor during the three months ended June 30, 2011. 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.

We used the proceeds of our stock offerings to purchase additional agency securities, provide working capital, and to provide liquidity for our hedging strategy.

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, 2011 and December 31, 2010, our total borrowings were approximately $14.8 billion and $8.7 billion (excluding accrued interest), respectively, which represented a leverage ratio of approximately 7.4:1 and 7.6:1, respectively. 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. Also, our leverage ratio will increase when asset prices drop, making some of the apparent safety of low leverage temporary.

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 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 extended 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, 2011, we had entered into interest rate swap agreements designed to mitigate the effects of increases in interest rates under $7.4 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

The 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 agency securities could effectively be limited by caps. Agency securities backed by 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 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 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, usually annually. We compute the projected weighted-average life of our agency securities backed by ARMs based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgage loans. In general, when agency securities backed by 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.

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, 2011 and December 31, 2010, 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, 2011

Change in Interest rates	Percentage Change in Projected Net Interest Income	Percentage Change in Projected Portfolio Value
+ 1.00%	(9.03%)	(1.76%)
+ 0.50%	(4.26%)	(0.56%)
- 0.50%	(0.60%)	0.06%
- 1.00%	(6.19%)	0.13%

December 31, 2010

Change in Interest rates	Percentage Change in Projected Net Interest Income	Percentage Change in Projected Portfolio Value
+ 1.00%	(7.25%)	(1.50%)
+ 0.50%	(3.0%)	(0.54%)
- 0.50%	1.48%	0.26%
- 1.00%	(3.68%)	0.38%

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, 2011 and December 31, 2010, 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 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, 2011, 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 quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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

Other than the following, 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, 2010 filed with the SEC on February 18, 2011.

The failure of U.S. lawmakers to reach an agreement on a national debt ceiling or budget may materially adversely affect our business, financial condition and results of operations.

The current U.S. debt ceiling and budget deficit concerns have increased the possibility of the credit-rating agencies downgrading the U.S. government’s credit rating for the first time in history. Further, as assets backed by Fannie Mae and Freddie Mac are considered to have the credit of the U.S. government, if the U.S. government’s credit rating was downgraded it would likely impact the credit risk associated with Agency MBS and, therefore, decrease the value of the Agency RMBS in our portfolio. In addition, a downgrade of the U.S. Government’s credit rating would likely create broader financial turmoil and uncertainty, which would weigh heavily on the global banking system.

In the event U.S. lawmakers fail to reach an agreement on a national debt ceiling or budget, the United States could default on its obligations, which could negatively impact the trading market for U.S. government securities. This may, in turn, negatively affect the value of our Agency MBS and our ability to obtain financing for our investments. As a result, it may materially adversely affect our business, financial condition and results of operations.

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

Exhibit Number	Description of Exhibit
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 (1)
Exhibit 101.SCH XBRL	Taxonomy Extension Schema Document (1)
Exhibit 101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document (1)
Exhibit 101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created (1)
Exhibit 101.LAB XBRL	Taxonomy Extension Label Linkbase Document (1)
Exhibit 101.PRE XBRL	Taxonomy Extension Presentation Linkbase Document (1)

(1) 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, 2011(Unaudited) and December 31, 2010 (Derived from the audited balance sheet at December 31, 2010); (ii) Statements of Income (Unaudited) for the three and six months ended June 30, 2011and 2010; (iii) Statement of Changes in Shareholders' Equity (Unaudited) for the six months ended June 30, 2011; (iv) Statements of Cash Flows (Unaudited) for the six months ended June 30, 2011and 2010; and (v) Notes to Financial Statements (Unaudited) for the six months ended June 30, 2011. 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.

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 1, 2011	BY:	/s/    KENNETH A. STEELE
		Kenneth A. Steele
		Chief Financial Officer, Treasurer and Secretary
		(Principal Financial Officer and Principal Accounting Officer)

EXHIBIT INDEX

Exhibit Number	Description of Exhibit
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 (1)
Exhibit 101.SCH XBRL	Taxonomy Extension Schema Document (1)
Exhibit 101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document (1)
Exhibit 101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created (1)
Exhibit 101.LAB XBRL	Taxonomy Extension Label Linkbase Document (1)
Exhibit 101.PRE XBRL	Taxonomy Extension Presentation Linkbase Document (1)

(1) 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, 2011(Unaudited) and December 31, 2010 (Derived from the audited balance sheet at December 31, 2010); (ii) Statements of Income (Unaudited) for the three and six months ended June 30, 2011and 2010; (iii) Statement of Changes in Shareholders' Equity (Unaudited) for the six months ended June 30, 2011; (iv) Statements of Cash Flows (Unaudited) for the six months ended June 30, 2011and 2010; and (v) Notes to Financial Statements (Unaudited) for the six months ended June 30, 2011. 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.