Hatteras Financial (HTS) 10-Q 2014 Q1 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 March 31, 2014

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 April 28, 2014
Common Stock ($0.001 par value)	96,515,027

TABLE OF CONTENTS

		Page
PART I	Financial Information
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	45
Item 4.	Controls and Procedures	48
PART II	Other Information
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Mine Safety Disclosures	49
Item 5.	Other Information	49
Item 6.	Exhibits	50
	Signatures	51

2

Hatteras Financial Corp.

Consolidated Balance Sheets

(Dollars in thousands, except share related amounts)
	(Unaudited)
	March 31, 2014			December 31, 2013
Assets
Mortgage-backed securities, at fair value
(including pledged assets of $15,897,380 and $17,049,670 at March 31, 2014	$	17,137,956		$	17,642,532
and December 31, 2013, respectively)
Cash and cash equivalents		250,258			763,326
Restricted cash		231,591			225,379
Unsettled purchased mortgage-backed securities, at fair value		157,201			-
Receivable for securities sold		-			231,214
Accrued interest receivable		53,629			55,156
Principal payments receivable		70,524			95,021
Debt security, held to maturity, at cost		15,000			15,000
Interest rate swap asset		12,703			15,841
Other assets		36,393			33,891
Total assets	$	17,965,255		$	19,077,360
Liabilities and shareholders’ equity
Repurchase agreements	$	15,183,457		$	16,129,683
Dollar roll liability		-			351,826
Payable for unsettled securities		157,387			-
Accrued interest payable		3,475			8,279
Interest rate swap liability		106,132			125,133
Futures contract liability		48,584			36,733
Dividend payable		52,885			52,929
Accounts payable and other liabilities		20,621			8,676
Total liabilities		15,572,541			16,713,259
Shareholders’ equity:
7.625% Series A Cumulative Redeemable Preferred stock, $.001 par value, 25,000,000 shares authorized, 11,500,000 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively ($287,500 aggregate liquidation preference)		278,252			278,252
Common stock, $.001 par value, 200,000,000 shares authorized, 96,515,027 and 96,601,523 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively		97			97
Additional paid-in capital		2,451,966			2,453,018
Accumulated deficit		(396,154	)		(359,214	)
Accumulated other comprehensive income (loss)		58,553			(8,052	)
Total shareholders’ equity		2,392,714			2,364,101
Total liabilities and shareholders’ equity	$	17,965,255		$	19,077,360

See accompanying notes.

3

Hatteras Financial Corp.

Consolidated Statements of Income

(Unaudited)

(Dollars in thousands, except share related amounts)
	Three Months Ended March 31
	2014			2013
Interest income:
Interest income on mortgage-backed securities	$	96,307		$	124,241
Interest income on short-term cash investments		282			442
Total interest income		96,589			124,683
Interest expense		38,451			53,277
Net interest margin		58,138			71,406
Operating expenses:
Management fee		4,154			4,720
Share based compensation		860			629
General and administrative		2,147			1,369
Total operating expenses		7,161			6,718
Other income (loss):
Net realized gain on sale of mortgage-backed securities		7,436			2,500
Gain (loss) on derivative instruments, net		(41,615	)		51
Total other income (loss)		(34,179	)		2,551
Net income		16,798			67,239
Dividends on preferred stock		5,480			5,480
Net income available to common shareholders	$	11,318		$	61,759
Earnings per share - common stock, basic	$	0.12		$	0.62
Earnings per share - common stock, diluted	$	0.12		$	0.62
Dividends per share of common stock	$	0.50		$	0.70
Weighted average common shares outstanding, basic		96,606,081			98,827,587
Weighted average common shares outstanding, diluted		96,606,081			98,827,587

See accompanying notes.

4

Hatteras Financial Corp

Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)
	Three Months Ended March 31
	2014		2013
Net income	$	16,798	$	67,239
Other comprehensive income:
Net unrealized gains (losses) on securities available for sale		34,138		(18,852	)
Net unrealized gains on derivative instruments		32,467		25,046
Other comprehensive income		66,605		6,194
Comprehensive income	$	83,403	$	73,433

See accompanying notes.

5

Hatteras Financial Corp.

Consolidated Statements of Changes in Shareholders’ Equity

For the Three Months Ended March 31, 2014

(Unaudited)

(Dollars in thousands)
	7.625% Series A Cumulative Redeemable Preferred Stock		Common Stock		Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Total
Balance at December 31, 2013	$	278,252	$	97	$	2,453,018		$	(359,214	)	$	(8,052	)	$	2,364,101
Repurchase of common stock		-		-		(1,912	)		-			-			(1,912	)
Share based compensation expense		-		-		860			-			-			860
Dividends declared on preferred stock		-		-		-			(5,480	)		-			(5,480	)
Dividends declared on common stock		-		-		-			(48,258	)		-			(48,258	)
Net income		-		-		-			16,798			-			16,798
Other comprehensive income		-		-		-			-			66,605			66,605
Balance at March 31, 2014	$	278,252	$	97	$	2,451,966		$	(396,154	)	$	58,553		$	2,392,714

See accompanying notes.

6

Hatteras Financial Corp.

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)
	Three Months Ended March 31
Operating activities	2014			2013
Net income	$	16,798		$	67,239
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premium related to mortgage-backed securities		22,091			43,208
Reclassification of deferred swap loss		24,684			-
Amortization related to interest rate swap agreements		69			83
Share based compensation expense		860			629
Hedge ineffectiveness		-			116
Net gain on sale of mortgage-backed securities		(7,436	)		(2,500	)
Net (gain) loss on derivative instruments		41,615			(51	)
Changes in operating assets and liabilities:
Decrease in accrued interest receivable		1,527			2,422
(Increase) decrease in other assets		(2	)		88
Decrease in accrued interest payable		(4,804	)		(2,552	)
Increase (decrease) in accounts payable and other liabilities		4,052			(276	)
Net cash provided by operating activities		99,454			108,406
Investing activities
Purchases of mortgage-backed securities		(948,925	)		(1,316,188	)
Principal repayments on mortgage-backed securities		768,532			1,534,530
Sales of mortgage-backed securities		960,291			132,630
Net payments on derivative instruments		(26,462	)		-
Purchases of equity securities		(6,000	)		-
Net cash provided by investing activities		747,436			350,972
Financing activities
Repurchase of common stock		(1,912	)		-
Cash dividends paid		(53,782	)		(74,656	)
Proceeds from repurchase agreements		44,262,079			63,814,319
Principal repayments on repurchase agreements		(45,208,305	)		(64,093,816	)
Proceeds from dollar roll liability		241,121			-
Repayments on dollar roll liability		(592,947	)		-
(Increase) decrease in restricted cash margin on derivatives		(6,212	)		41,604
Net cash used in financing activities		(1,359,958	)		(312,549	)
Net increase (decrease) in cash and cash equivalents		(513,068	)		146,829
Cash and cash equivalents, beginning of period		763,326			168,424
Cash and cash equivalents, end of period	$	250,258		$	315,253
Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	47,915		$	55,777
Supplemental schedule of non-cash investing  and financing activities
Obligation to brokers for purchase of unsettled mortgage-backed securities	$	157,387		$	1,229,848
Dividends declared on preferred stock, not yet paid	$	4,627		$	4,628
Dividends declared on common stock, not yet paid	$	48,258		$	69,181

See accompanying notes.

7

Hatteras Financial Corp.  

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

(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.  The Company invests primarily in single-family residential mortgage assets, such as mortgage-backed securities (“MBS”), issued or guaranteed by the U.S. Government - Ginnie Mae - or by the U.S. Government sponsored enterprises - Fannie Mae and Freddie Mac - (“agency securities”).  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.  However, certain activities that the Company may perform may cause it to earn income which will not be qualifying income for REIT purposes.  The Company has designated certain of its subsidiaries as taxable REIT subsidiaries (“TRSs”) as defined in the Code to engage in such activities, and the Company may in the future form additional TRSs.  

2.       Summary of Significant Accounting Policies

Basis of Presentation and Use of Estimates

The accompanying unaudited consolidated 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 months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2014.  These unaudited consolidated 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, 2013.  

The preparation of the consolidated 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 consolidated 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 consolidated financial statements include the valuation of agency securities and derivative instruments.  

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and all of its subsidiaries.  The Company also considers the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 810 on Consolidation in determining whether consolidation is appropriate for any interests held in variable interest entities.  All significant intercompany balances and transactions have been eliminated.  

Financial Instruments

The Company considers its cash and cash equivalents, restricted cash, agency securities (settled and unsettled), forward purchase commitments, debt security held to maturity, receivable for securities sold, accrued interest receivable, principal payment receivable, payable for unsettled securities, derivative instruments, repurchase agreements, dollar roll liabilities and accrued interest payable to meet the definition of financial instruments.  The carrying amount of cash and cash equivalents, restricted cash, receivable for securities sold, accrued interest receivable, dollar roll liabilities and payable for unsettled securities approximate their fair value due to the short maturities of these instruments and are valued using Level 1 inputs.  The carrying amount of repurchase agreements is deemed to approximate fair value given their short-term duration and are valued using Level 2 inputs.  See Note 4 for discussion of the fair value of agency securities and forward purchase commitments.  See Note 5 for discussion of the fair value of the held to maturity debt security.  See Note 7 for discussion of the fair value of derivative instruments.  

8

The Company limits its exposure to credit losses on its portfolio of securities by purchasing predominantly agency securities.  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 expected prepayment characteristics.  See Note 4 for additional information on MBS.  

The Company is engaged in various trading and brokerage activities including repurchase agreements, dollar rolls, interest rate swap agreements and futures contracts 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 6 for additional information on repurchase agreements and Note 7 for additional information on dollar rolls, interest rate swap agreements and futures contracts.  

Mortgage-Backed Securities

The Company invests predominantly in agency securities representing interests in or obligations backed by pools of single-family residential mortgage loans.  Guidance under the FASB ASC Topic 820 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 securities 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 (loss).  The estimated fair values of agency securities are determined by management by obtaining valuations for its agency securities from 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 (“ASC 815”).  The fair value of these purchase commitments is included in other assets or liabilities in the accompanying consolidated balance sheets.  If the Company intends to take physical delivery of the security, the commitment is designated as an all-in-one cash flow hedge and its unrealized gains and losses are recorded in other comprehensive income.  If the Company does not intend to take physical delivery, as is the case with TBA dollar rolls, the commitment is not designated as an accounting hedge and unrealized gains and losses are recorded in “Gain (loss) on derivative instruments, net.”

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 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.  No impairment losses were recognized during the periods presented.  

Derivative Instruments

The Company manages economic risks, including interest rate, liquidity and credit risks, primarily by managing the amount, sources, cost, and duration of its debt funding.  The objectives of the Company’s risk management strategy are 1) to attempt to mitigate the risk of the cost of its variable rate liabilities increasing during a period of rising interest rates, and 2) to reduce fluctuations in net book value over a range of interest rate scenarios.  The principal instruments that the Company uses to achieve these objectives are interest rate swaps and Eurodollar Futures Contracts (“Futures Contracts”).  The Company uses Futures Contracts to approximate the economic hedging results achieved with interest rate swaps.  The Company does not enter into any of these transactions for speculative purposes.  

The Company accounts for derivative instruments in accordance with ASC 815, which requires an entity to recognize all derivatives as either assets or liabilities and to measure those instruments at fair value.  The accounting for changes in the fair value of derivative instruments depends on whether the instruments are designated and qualify as part of a hedging relationship pursuant to ASC 815.  Changes in fair value related to derivatives not in hedge designated relationships are recorded in “Gain (loss) on derivative instruments, net” in the Company’s consolidated statements of income, whereas changes in fair value related to derivatives in hedge designated relationships are initially recorded in other comprehensive income (loss) and later reclassified to income at the time that the hedged transactions affect earnings.  Any portion of the changes in fair value due to hedge ineffectiveness is immediately recognized in the income statement.  

Derivative instruments in a gain position are reported as derivative assets at fair value and derivative instruments in a loss position are reported as derivative liabilities at fair value in the Company’s consolidated balance sheets.  In the Company’s consolidated statements of cash flows, cash receipts and payments related to derivative instruments are classified according to the underlying nature or purpose of the derivative transaction, generally in the operating section if the derivatives are designated as

9

accounting hedges and in the investing section otherwise.  The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts.  The Company attempts to minimize this risk by limiting its counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required.  

All of the Company’s swaps have historically been accounted for as cash flow hedges under ASC 815.  However, on September 30, 2013, the Company discontinued hedge accounting for its interest rate swap agreements by de-designating the swaps as cash flow hedges.  No swaps were terminated in conjunction with this action, and the Company’s risk management and hedging practices were not impacted.  As a result of discontinuing hedge accounting, beginning October 1, 2013 changes in the fair value of the Company’s interest rate swap agreements are recorded in “Gain (loss) on derivative instruments, net” in the Company’s consolidated statements of income, rather than in other comprehensive income (loss).  Also, net interest paid or received under the swaps, which up through September 30, 2013 was recognized in “interest expense,” is instead recognized in “Gain (loss) on derivative instruments, net.” These swaps continue to be reported as assets or liabilities on the Company’s consolidated balance sheets at their fair value.  

As long as the forecasted transactions that were being hedged (i.e. rollovers of the Company’s repurchase agreement borrowings) are still expected to occur, the balance in accumulated other comprehensive income (AOCI) from swap activity up through September 30, 2013 will remain in AOCI and be recognized in the Company’s consolidated statements of income as “interest expense” over the remaining term of the swaps.  See Note 7 for further information.  

At times, the Company may also enter into TBA contracts as a means of investing in and financing agency securities via “dollar roll” transactions.  TBA dollar roll transactions involve moving the settlement of a TBA contract out to a later date by entering into an offsetting short position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously purchasing a similar TBA contract for a later settlement date.  The agency securities purchased at the forward settlement date are typically priced at a discount to securities for settlement in the current month.  This difference is referred to as the “price drop.” The price drop represents compensation to the Company for foregoing net interest margin (interest income less repurchase agreement financing cost) and is referred to as “dollar roll income,” which the Company classifies in “Gain (loss) on derivative instruments, net.” Realized and unrealized gains and losses related to TBA contracts are also recognized in “Gain (loss) on derivative instruments, net.” TBA dollar roll transactions represent off-balance sheet financing.  

Repurchase Agreements

The Company finances the acquisition of its agency securities through the use of repurchase agreements.  Under these repurchase agreements, the Company sells securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sales price.  The difference between the sale price that the Company receives and the repurchase price that the Company pays represents interest paid to the lender.  Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which the Company pledges its securities as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral.  The Company retains beneficial ownership of the pledged collateral.  At the maturity of a repurchase agreement, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender or, with the consent of the lender, the Company may renew such agreement at the then prevailing financing rate.  These repurchase agreements may require the Company to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.  

Dollar Roll Liability

In addition to the TBA dollar roll transactions described above, the Company may from time to time execute dollar roll transactions on agency securities (“CUSIP dollar rolls”).  These transactions represent on-balance sheet financing, presented as “Dollar roll liability” in the Company’s consolidated balance sheets.  During the period of a CUSIP dollar roll, the financed security remains on the Company’s balance sheet, and the components of the net interest margin earned from the price drop are classified in “interest income on mortgage-backed securities” and “interest expense,” respectively.  

Offsetting of Assets and Liabilities

The Company’s derivative agreements and repurchase agreements generally contain provisions that allow for netting or the offsetting of receivables and payables with each counterparty.  The Company reports amounts in its consolidated balance sheets on a gross basis without regard for such rights of offset or master netting arrangements.  

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.  

10

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.  The Company and two of its subsidiaries have made an election to treat these subsidiaries as TRSs.  As such, these TRSs are taxable as domestic C corporations and are subject to federal, state and local income taxes based upon their taxable income.  

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 $860 and $629 for the three months ended March 31, 2014 and 2013, respectively.  

Earnings Per Common Share (EPS)

Basic EPS is computed by dividing net income less preferred stock dividends to arrive at 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.  Participating securities are unvested share-based awards that contain rights to receive nonforfeitable dividends, such as those awarded under the Company’s equity incentive plan.  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, if any.  

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.  

Other than the Futures Contracts, all of the Company’s agency securities and other derivatives were valued using Level 2 inputs at March 31, 2014 and December 31, 2013.  The Futures Contracts were valued using Level 1 inputs at March 31, 2014 and December 31, 2013.  See Notes 4 and 7, respectively, for discussion on how agency securities and other derivatives were valued.  

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The carrying values and fair values of all financial instruments as of March 31, 2014 and December 31, 2013 were as follows:

	March 31, 2014				December 31, 2013
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Mortgage-backed securities	$	17,137,956	$	17,137,956	$	17,642,532	$	17,642,532
Cash and cash equivalents		250,258		250,258		763,326		763,326
Restricted cash		231,591		231,591		225,379		225,379
Unsettled purchased mortgage backed securities		157,201		157,201		-		-
Accrued interest receivable		53,629		53,629		55,156		55,156
Receivable for securities sold		-		-		231,214		231,214
Principal payments receivable		70,524		70,524		95,021		95,021
Debt security, held to maturity		15,000		14,482		15,000		14,307
Interest rate swap asset		12,703		12,703		15,841		15,841
Futures Contracts*		5,617		5,617		11,148		11,148
Short term investment*		20,052		20,052		19,910		19,910
Forward purchase commitments*		2,042		2,042		-		-
Liabilities
Repurchase agreements	$	15,183,457		15,183,457	$	16,129,683	$	16,129,683
Dollar roll liabilities		-		-		351,826		351,826
Payable for unsettled securities		157,387		157,387		-		-
Accrued interest payable		3,475		3,475		8,279		8,279
Interest rate swap liability		106,132		106,132		125,133		125,133
Futures contract liability		48,584		48,584		36,733		36,733
Forward purchase commitments**		13,634		13,634		5,741		5,741

*These lines are included in other assets on the consolidated balance sheets.

**This line is included in accounts payable and other liabilities on the consolidated balance sheets.

4.      Mortgage-Backed Securities

All of the Company’s agency securities were classified as available-for-sale and, as such, are reported at their estimated fair value.  The agency securities market is primarily an over-the-counter market.  As such, there are no standard, public market quotations or published trading data for individual agency securities.  The Company estimates the fair value of the Company’s agency securities based on a market approach obtaining values for its securities primarily from third-party pricing services and dealer quotes.  To ensure the Company’s fair value determinations are consistent with the ASC Topic on Fair Value Measurements and Disclosures, the Company regularly reviews the prices obtained and the methods used to derive those prices.  The Company evaluates the pricing information it receives taking into account factors such as coupon, prepayment experience, fixed/adjustable rate, annual and life caps, coupon index, time to next reset and issuing agency, among other factors to ensure that estimated fair values are appropriate.  The Company reviews the methods and inputs used by providers of pricing data to determine that the fair value of its assets and liabilities are properly classified in the fair value hierarchy.  

The third-party pricing services gather trade data and use pricing models that incorporate such factors as coupons, primary mortgage rates, prepayment speeds, spread to the U.S. Treasury and interest rate swap curves, periodic and life caps and other similar factors.  Traders at broker-dealers function as market-makers for these securities, and these brokers have a direct view of the trading activity.  

Brokers do not receive compensation for providing pricing information to the Company.  The broker prices received are non-binding offers to trade.  The brokers receive data from 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.  The Company’s analysis of fair value for these includes comparing the data received to other information, if available, such as repurchase agreement pricing or internal pricing models.  

If the fair value of a security is not available using the Level 2 inputs as described above, 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

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fundamental analysis of observable market factors.  At March 31, 2014 and December 31, 2013, all of the Company’s agency securities values were based on third-party sources.  

The Company’s investment portfolio consists of agency securities, which are backed by a U.S. Government agency or a U.S. Government sponsored enterprise.  The following table presents certain information about the Company’s agency securities at March 31, 2014.  

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency Securities
Fannie Mae Certificates
ARMs	$	9,553,321	$	(36,442	)	$	171,484	$	9,688,363
Fixed Rate		303,611		(345	)		817		304,083
Total Fannie Mae		9,856,932		(36,787	)		172,301		9,992,446
Freddie Mac Certificates
ARMs		6,964,182		(54,734	)		63,071		6,972,519
Fixed Rate		173,086		(196	)		101		172,991
Total Freddie Mac		7,137,268		(54,930	)		63,172		7,145,510
Total Agency Securities	$	16,994,200	$	(91,717	)	$	235,473	$	17,137,956

The following table presents certain information about the Company’s agency securities at December 31, 2013.  

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value
Agency Securities
Fannie Mae Certificates
ARMs	$	9,620,743	$	(44,871	)	$	167,848	$	9,743,720
Fixed Rate		806,312		(1,798	)		3,832		808,346
Total Fannie Mae		10,427,055		(46,669	)		171,680		10,552,066
Freddie Mac Certificates
ARMs		6,671,013		(70,752	)		57,808		6,658,069
Fixed Rate		338,738		(1,600	)		21		337,159
Total Freddie Mac		7,009,751		(72,352	)		57,829		6,995,228
Ginnie Mae Certificates
ARMs		—		—			—		—
Fixed Rate		96,236		(998	)		—		95,238
Total Ginnie Mae		96,236		(998	)		—		95,238
Total Agency Securities	$	17,533,042	$	(120,019	)	$	229,509	$	17,642,532

The components of the carrying value of available-for-sale agency securities at March 31, 2014 and December 31, 2013 are presented below.  

	March 31, 2014			December 31, 2013
Principal balance	$	16,525,003		$	17,044,190
Unamortized premium		469,197			488,854
Unamortized discount		-			(2	)
Gross unrealized gains		235,473			229,509
Gross unrealized losses		(91,717	)		(120,019	)
Carrying value/estimated fair value	$	17,137,956		$	17,642,532

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The following table presents components of interest income on the Company’s agency securities portfolio for the three months ended March 31, 2014 and 2013.  

	Three Months Ended March 31
	2014			2013
Coupon interest on MBS	$	118,398		$	167,434
Net premium amortization		(22,091	)		(43,193	)
Interest income on MBS, net	$	96,307		$	124,241

Gross gains and losses from sales of securities for the three months ended March 31, 2014 and 2013 were as follows.  

	Three Months Ended March 31
	2014		2013
Gross gains on MBS	$	7,436	$	2,500
Gross losses on MBS		-		-
Net gain (loss) on MBS	$	7,436	$	2,500

The Company monitors the performance and market value of its agency securities portfolio on an ongoing basis, and on a quarterly basis reviews its agency securities for impairment.  At March 31, 2014 and December 31, 2013, the Company had the following securities in a loss position presented below:

	Less than 12 months					Less than 12 months
	as of March 31, 2014					as of December 31, 2013
	Fair Market		Unrealized			Fair Market		Unrealized
	Value		Loss			Value		Loss
Fannie Mae Certificates
ARMs	$	3,133,610	$	(36,442	)	$	3,233,274	$	(44,871	)
Fixed Rate		171,707		(345	)		281,760		(1,798	)
Freddie Mac Certificates
ARMs		3,806,999		(54,734	)		4,046,473		(70,752	)
Fixed Rate		153,804		(196	)		316,835		(1,600	)
Ginnie Mae Certificates
ARMs		-		-			-		-
Fixed Rate		-		-			95,238		(998	)
Total temporarily impaired securities	$	7,266,120	$	(91,717	)	$	7,973,580	$	(120,019	)
Number of securities in an unrealized loss position				233					279

The Company did not make the decision to sell the above securities as of March 31, 2014 and December 31, 2013, 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 contractual maturity of the Company’s agency securities ranges from 15 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.  

5.       Debt Security, Held to Maturity

The Company owns a $15,000 debt security from a repurchase lending counterparty that matures March 24, 2019.  The debt security pays interest quarterly at the rate of 4.0% above the three-month London Interbank Offered Rate (“LIBOR”).  The Company estimates the fair value of this note to be approximately $14,482 and $14,307 at March 31, 2014 and December 31, 2013, respectively, which was determined by calculating the present value of the projected future cash flows using a discount rate from a similar issuer.  

6.       Repurchase Agreements

At March 31, 2014 and December 31, 2013, the Company had repurchase agreements in place in the amount of $15,183,457 and $16,129,683, respectively, to finance MBS purchases.  As of March 31, 2014 and December 31, 2013, the weighted average interest rate on these borrowings was 0.33% and 0.37%, respectively.   The Company’s repurchase agreements are collateralized by the

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Company’s agency securities and typically bear interest at rates that are closely related to LIBOR.  At March 31, 2014 and December 31, 2013, the Company had repurchase indebtness outstanding with 25 counterparties, with a weighted average contractual maturity of 0.8 months.  The following table presents the contractual repricing information regarding the Company’s repurchase agreements:

	March 31, 2014					December 31, 2013
			Weighted Average					Weighted Average
	Balance		Contractual Rate			Balance		Contractual Rate
Within 30 days	$	13,752,842		0.28	%	$	13,170,898		0.37	%
30 days to 3 months		1,430,615		0.63	%		2,958,785		0.40	%
	$	15,183,457		0.33	%	$	16,129,683		0.37	%

The fair value of securities, cash, and accrued interest the Company had pledged under repurchase agreements at March 31, 2014 and December 31, 2013 was $15,933,514 and $17,088,392, respectively.  

See Note 2 for a discussion of TBA dollar roll transactions, which represent off-balance sheet financing.  

7.       Derivatives and Other Hedging Instruments

In connection with the Company’s risk management strategy, the Company hedges a portion of its interest rate risk by entering into derivative contracts.  The Company may enter into agreements for interest rate swaps, interest rate swaptions, interest rate cap or floor contracts and futures or forward contracts.  The Company’s risk management strategy attempts to manage the overall risk of the portfolio, reduce fluctuations in book value and generate additional income distributable to shareholders.  For additional information regarding the Company’s derivative instruments and its overall risk management strategy, please refer to the discussion of derivative instruments in Note 2.  

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 fair value of Futures Contracts is based on quoted prices from the exchange on which they trade.  The table below presents the fair value of the Company’s derivative instruments as well as their classification on the consolidated balance sheets as of March 31, 2014 and December 31, 2013, respectively.  

Derivative Instruments	Balance Sheet Location	March 31, 2014		December 31, 2013
Interest rate swaps	Interest rate swap asset	$	12,703	$	15,841
Futures contracts	Other assets		5,617		11,148
Forward purchase commitments	Other assets		2,042		-
Interest rate swaps	Interest rate swap liability	$	106,132	$	125,133
Futures contracts	Futures contract liability		48,584		36,733
Forward purchase commitments including TBA dollar rolls	Accounts payable and other liabilities		13,634		5,741

Interest Rate Swaps

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.  Interest rate swaps 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 lockup interest rates on a portion of the Company’s repurchase agreements for the terms of the swaps.  Although the Company’s objective is to hedge the risk associated with changing repurchase agreement rates, the Company’s swaps are benchmark interest rate swaps which perform with reference to LIBOR.  Therefore, the Company remains at risk to the variability of the spread between repurchase agreement rates and LIBOR interest rates.  

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Until September 30, 2013, the Company elected cash flow hedge accounting for its interest rate swaps.  Under cash flow hedge accounting, effective hedge gains or losses are initially recorded in other comprehensive income and subsequently reclassified into net income in the period that the hedged forecasted transaction affects earnings.  Ineffective hedge gains and losses are recorded on a current basis 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.  See “Financial Statement Presentation” below for quantification of gains and losses for the three months ended March 31, 2014 and 2013.  

On September 30, 2013, the Company de-designated its interest rate swaps as cash flow hedges, thus terminating cash flow hedge accounting.  As long as the forecasted rollovers of the related repurchase agreements are still expected to occur, amounts in AOCI related to the cash flow hedges through September 30, 2013 will remain in AOCI and will continue to be reclassified to interest expense as interest is accrued and paid on the related repurchase agreements.  During the next 12 months, the Company estimates that an additional $72,052 will be reclassified out of AOCI as an increase to interest expense.  

The Company will continue to hedge its exposure to variability in future funding costs via interest rate swaps.  As a result of discontinuing hedge accounting, beginning October 1, 2013, changes in the fair value of the Company’s interest rate swaps are recorded in “Gain (loss) on derivative instruments, net” in the consolidated statements of income, consistent with the Company’s historical accounting for Futures Contracts, as described below.  Monthly net cash settlements under the swaps are also recorded in “Gain (loss) on derivative instruments, net” beginning October 1, 2013.  

The volume of activity for the Company’s interest rate swap instruments is shown in the table below.  

	Three Months Ended March 31
	2014			2013
Notional amount, beginning of period	$	10,700,000		$	10,700,000
Additions		-			600,000
Expirations and terminations		(600,000	)		(200,000	)
Notional amount, end of period	$	10,100,000		$	11,100,000

As of March 31, 2014, the weighted-average remaining term of the Company’s interest rate swaps is 22 months. Additional information regarding the Company’s interest rate swaps as of March 31, 2014 follows.  

			Remaining		Weighted Average
	Notional		Term		Fixed Interest
Maturity	Amount		in Months		Rate in Contract
12 months or less	$	2,800,000		8		1.80%
Over 12 months to 24 months		3,300,000		17		1.53%
Over 24 months to 36 months		2,400,000		30		0.95%
Over 36 months to 48 months		1,600,000		41		0.87%
Total	$	10,100,000		22		1.36%

Eurodollar Futures Contracts

The Company uses Futures Contracts to 1) synthetically replicate an interest rate swap, or 2) offset the changes in value of its forward purchases of certain agency securities.  As of March 31, 2014 and December 31, 2013, the fair value of all Futures Contracts was a liability of $(42,967) and $(25,585), respectively.  

	Fair Value
	March 31, 2014			December 31, 2013
Futures Contracts designed to replicate swaps	$	(45,537	)	$	(27,881	)
Futures Contracts designed to hedge value changes in forward purchases		2,570			2,296
Total fair market value of Futures Contracts	$	(42,967	)	$	(25,585	)

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The volume of activity for the Company’s Futures Contracts is shown in the table below.  

	Number ofContracts
As of December 31, 2013		95,327
New positions opened		77,821
Early settlements		(56,817	)
Settlements at maturity		(2,006	)
As of March 31, 2014		114,325

Each Futures Contract embodies $1 million of notional value and is effective for a term of approximately three months.  

The Company has not designated its Futures Contracts as hedges for accounting purposes.  As a result, realized and unrealized changes in fair value thereon are recognized in earnings in the period in which the changes occur.  During the three months ended March 31, 2014, the Company recognized realized and unrealized losses on Futures Contracts of $(18,606) and $(17,382), respectively, in “Gain (loss) on derivative instruments, net.” The Company recognized a realized gain of $51 on Futures Contracts during the three months ended March 31, 2013.  

To Be Announced Securities Purchases

The Company purchases certain of its investment securities in the forward market.  The Company purchases ARM TBA contracts and 15-year TBA contracts from dealers.  ARM TBA contracts are not a frequently-traded security and are generally used to acquire MBS for the portfolio.  15-year TBA contracts are a highly liquid security, and may be physically settled, net settled or traded as an investment.  The Company also has commitments with various mortgage origination companies to purchase their production as it becomes securitized.  Forward purchases do not qualify for trade date accounting and are considered derivatives for financial statement purposes.  The net fair value of the forward commitment is reported on the balance sheet as an asset (or liability).  Whether the unrealized gain (or loss) is recognized in net income or other comprehensive income depends on whether or not the commitment has been designated as an accounting hedge, as discussed in Note 2.

The following table shows the ARM securities forward purchase commitments shown as a net asset in other assets on the balance sheets as of March 31, 2014 and December 31, 2013.  

		Face		Cost		Fair Value		Net Asset
March 31, 2014	$	70,000	$	71,839	$	72,040	$	201
December 31, 2013	$	-	$	-	$	-	$	-

15-year TBA contracts may be financed in the dollar roll market.  Income from dollar roll transactions and realized and unrealized gains and losses on TBA contracts are recognized in “Gain (loss) on derivative instruments, net.”

At March 31, 2014 and December 31, 2013, the Company had the following 15-year TBA dollar roll securities:

	Face		Cost		Fair Value		Net Asset (Liability)
March 31, 2014	$	3,400,000	$	3,565,399	$	3,551,765	$	(13,634	)
December 31, 2013	$	600,000	$	632,270	$	627,187	$	(5,083)

At March 31, 2014 and December 31, 2013, the Company also had estimated purchase commitments with mortgage originators with a net fair value in the amount of $1,841 and ($658), respectively.  

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Financial Statement Presentation

The Company does not use either offsetting or netting to present any of its derivative assets or liabilities.  The following table shows the gross amounts associated with the Company’s derivative financial instruments and the impact if netting were used as of March 31, 2014.  

	Assets/(Liabilities)			Cash Collateral Posted		Net Asset/(Liability)
Interest rate swaps	$	12,703		$	-	$	12,703
Futures contracts		5,617			-		5,617
Forward purchase commitments		2,042			-		2,042
Interest rate swaps	$	(106,132	)	$	111,898	$	5,766
Futures contracts		(48,584	)		106,298		57,714
Forward purchase commitments including TBA dollar rolls		(13,634	)		13,395		(239)

The following table shows the gross amounts associated with the Company’s derivative financial instruments and the impact if netting were used as of December 31, 2013.  

	Assets/(Liabilities)			Cash Collateral Posted		Net Asset/(Liability)
Interest rate swaps	$	15,841		$	-	$	15,841
Futures contracts		11,148			-		11,148
Interest rate swaps	$	(125,133	)	$	133,661	$	8,528
Futures contracts		(36,733	)		77,713		40,980
Forward purchase commitments including TBA dollar rolls		(5,741	)		14,005		8,264

The following table shows the components of “Gain (loss) on derivative instruments, net” for the three months ended March 31, 2014 and 2013.  Impacts from the Company’s interest rate swaps subsequent to the September 30, 2013 hedge de-designation are included herein.  

	Three Months Ended March 31
	2014			2013
Interest rate swaps – fair value adjustments	$	15,863		$	-
Interest rate swaps – monthly net settlements		(29,412	)		-
Futures Contracts – fair value adjustments		(17,382	)		-
Futures Contracts – realized gains (losses)		(18,606	)		51
TBA dollar roll income		20,821			-
Realized and unrealized losses on TBA securities		(12,899	)		-
Gain (loss) on derivative instruments, net	$	(41,615	)	$	51

See Note 2 for discussion of dollar roll transactions and dollar roll income.  

As discussed above, effective September 30, 2013, the Company discontinued cash flow hedge accounting for its interest rate swaps.  The table below presents the effect of the swaps that were previously designated as cash flow hedges on the Company’s comprehensive income for the three months ended March 31, 2014 and 2013.  

	Three Months Ended March 31
	2014			2013
Amount of gain (loss) recognized in OCI (effective portion)	$	-		$	(5,907	)
Amount of loss reclassified from OCI into net income as interest expense (effective portion)		(24,684	)		(29,929	)
Amount of loss recognized in net income as interest expense (ineffective portion)		-			(116	)

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The following table presents the impact of the Company’s interest rate swap agreements on the Company’s AOCI for the three months ended March 31, 2014 and the year ended December 31, 2013.  

	Three Months Ended March 31, 2014			Year Ended December 31, 2013
Beginning balance	$	(111,174	)	$	(243,051	)
Unrealized gain on interest rate swaps		-			15,030
Reclassification of net losses included in income statement		24,684			116,847
Ending balance	$	(86,490	)	$	(111,174	)

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 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 agreements with several of its derivative counterparties that contain provisions regarding maximum leverage ratios.  The most restrictive of these leverage covenants is that if the Company exceeds a leverage ratio of 10 to 1 then the Company could be declared in default on its derivative obligations with that counterparty.  At March 31, 2014, the Company was in compliance with these requirements.  

As of March 31, 2014, the fair value of derivatives in a net liability position related to these agreements was $93,429.  The Company has collateral posting requirements with each of its counterparties and all interest rate swap agreements were fully collateralized as of March 31, 2014.

8.       Capital Stock

Issuance of Common Stock- “At the Market” Programs

From time to time, the Company may sell shares of its common stock in “at-the-market” offerings.  Sales of 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 of 1933, as amended, including sales made directly on the New York Stock Exchange or to or through a market maker other than on an exchange.  

On February 29, 2012, the Company entered into sales agreements (the “2012 Sales Agreements”) with Cantor Fitzgerald & Co.  (“Cantor”) and JMP Securities LLC (“JMP”) to establish a new “at-the-market” program (the “2012 Program”).  Under the terms of the 2012 Sales Agreements, the Company may offer and sell up to 10,000,000 shares of its common stock from time to time through Cantor or JMP, each acting as agent and/or principal.  The shares of common stock issuable pursuant to the 2012 Program are registered with the Securities and Exchange Commission on the Company’s Registration Statement on Form S-3 (No.  333-179805), which became effective upon filing on February 29, 2012.  

For the three months ended March 31, 2014 and 2013, the Company did not issue any shares of stock under the 2012 Program.  

Stock Repurchase Program

On June 18, 2013, the Company’s board of directors authorized a stock repurchase program (the “Repurchase Program”) to acquire up to 10,000,000 shares of the Company’s common stock.  For the three months ended March 31, 2014, the Company repurchased 100,000 shares of common stock under the Repurchase Program in at-the-market transactions at a total cost of $1,912.  

During periods when the Company’s board of directors has authorized the Company to repurchase shares under the Repurchase Program, the Company will not be authorized to issue shares of common stock under the 2012 Program described above.  Similarly, during periods when the Company’s board of directors has authorized the Company to issue shares of common stock under the 2012 Program, the Company will not be authorized to repurchase shares under the Repurchase Program.  

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9.      Earnings per Share

The following table details the Company’s calculation of earnings per share for the three months ended March 31, 2014 and 2013.  

	Three Months Ended March 31
	2014			2013
Basic earnings per share:
Net income	$	16,798		$	67,239
Less preferred stock dividends		(5,480	)		(5,480	)
Net income available to common shareholders	$	11,318		$	61,759
Weighted average shares		96,606,081			98,827,587
Basic earnings per share	$	0.12		$	0.62
Diluted earnings per share:
Net income	$	16,798		$	67,239
Less preferred stock dividends for antidilutive shares		(5,480	)		(5,480	)
Net income available to common shareholders	$	11,318		$	61,759
Weighted average shares		96,606,081			98,827,587
Potential dilutive shares from exercise of stock options		-			-
Diluted weighted average shares		96,606,081			98,827,587
Diluted earnings per share	$	0.12		$	0.62

There were no potentially dilutive shares for the three months ended March 31, 2014 and 2013.  

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 February 23, 2015 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 four 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.  

Under the terms of the Management Agreement, the Company reimburses ACA for certain operating expenses of the Company that are borne by ACA.  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.  

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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.  The following table presents amounts incurred for management fee and reimbursable expenses.  

	Three Months Ended March 31
	2014		2013
Management Fee	$	4,154	$	4,720
Reimbursable Expenses		812		579
Total	$	4,966	$	5,299

None of the reimbursement payments were specifically attributable to the compensation of the Company’s executive officers.  At March 31, 2014 and December 31, 2013, the Company owed ACA $4,986 and $2,752, respectively, for the management fee and reimbursable expenses, which is included in accounts payable and other liabilities.  

In addition, the Company recognized share based compensation expense related to restricted common shares granted to management of $860 and $629 for the three months ended March 31, 2014 and 2013, respectively.  

11.      Accumulated Other Comprehensive Income

The Company records unrealized gains and losses on its agency securities and its TBA securities as described in Note 4.  As discussed in Note 7, the Company ceased hedge accounting for its interest rate swaps effective September 30, 2013.  Beginning October 1, 2013, changes in the fair value of interest rate swaps are recorded directly to net income.  The cumulative unrealized loss on interest rate swaps in AOCI as of September 30, 2013 is being amortized to net income as the hedged forecasted transactions occur.  The following table rolls forward the components of AOCI, including reclassification adjustments, for the three months ended March 31, 2014.  

	Unrealized gain/(loss) on available for sale agency securities			Unrealized gain/(loss) on unsettled agency securities			Unrealized gain/(loss) on other investments			Unrealized gain/(loss) on derivative instruments			Total
Accumulated other comprehensive income (loss) at January 1, 2014	$	109,491		$	-		$	(628	)	$	(116,915	)	$	(8,052	)
Other comprehensive income (loss) before reclassification		41,701			(186	)		59			2,042			43,616
Balance Sheet Reclassification:
Amount reclassified to mortgage-backed securities available for sale		-			-			-			658			658
Income Statement Reclassification:
Amounts reclassified to net gain on the sale of mortgage-backed securities		(7,436	)		-			-			-			(7,436	)
Amounts reclassified for termination of all-in-one cash flow hedge accounting on dollar roll TBAs		-			-			-			5,083			5,083
Amounts reclassified to interest expense		-			-			-			24,684			24,684
Net current period other comprehensive income (loss)		34,265			(186	)		59			32,467			66,605
Accumulated other comprehensive income (loss) at March 31, 2014	$	143,756		$	(186	)	$	(569	)	$	(84,448	)	$	58,553

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The following table rolls forward the components of AOCI, including reclassification adjustments, for the three months ended March 31, 2013.  

	Unrealized gain/(loss) on available for sale agency securities			Unrealized gain/(loss) on unsettled agency securities			Unrealized gain/(loss) on other investments			Unrealized gain/(loss) on derivative instruments			Total
Beginning balance, accumulated other comprehensive income (loss) at January 1, 2013	$	499,343		$	1,217		$	(107	)	$	(237,599	)	$	262,854
Other comprehensive income (loss) before reclassifications		(15,520	)		492			(107	)		569			(14,566	)
Balance Sheet Reclassification:
Amount reclassified to mortgage-backed securities available for sale		—			(1,217	)		—			(5,452	)		(6,669	)
Income Statement Reclassifications:
Amounts reclassified to net gain on the sale of mortgage-backed securities		(2,500	)		—			—			—			(2,500	)
Amounts reclassified to interest expense		—			—			—			29,929			29,929
Net current period other comprehensive income (loss)		(18,020	)		(725	)		(107	)		25,046			6,194
Ending balance, accumulated other comprehensive income (loss) at March 31, 2013	$	481,323		$	492		$	(214	)	$	(212,553	)	$	269,048

12.      Subsequent Event

On April 1, 2014, the Company purchased 100% of the outstanding stock of a privately-held, non-clearing broker-dealer for a purchase price of $2.4 million.  The purchase price was paid in cash and future purchase price adjustments are not expected.

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

In this Quarterly Report on Form 10-Q, we refer to Hatteras Financial Corp.  as “we,” “us,” “our company,” or “our,” unless we specifically state otherwise or the context indicates otherwise.  The following defines certain of the commonly used terms in this quarterly report on Form 10-Q: “MBS” refers to mortgage-backed securities; 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, 2013, filed with the Securities and Exchange Commission (“SEC”) on February 21, 2014.  

Amounts other than share-related amounts are presented in thousands, unless otherwise noted.

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,” “may,” “will,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” or the negative of these words and 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.  

The forward-looking statements in this report 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 strategies; 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 investments; 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 set forth under the section captioned “Risk Factors” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and in our annual report on Form 10-K for the year ended December 31, 2013, as updated by 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 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.  We listed our common stock on the New York Stock Exchange (“NYSE”) in April 2008 and trade 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 currently distribute our income to our shareholders and maintain our qualification as a REIT.  

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Our principal goal is to generate net income for distribution to our shareholders through regular quarterly dividends.  Our income is generated by the difference between the earnings on our investment portfolio and the costs of our borrowings and hedging activities and other expenses.  In general, our strategy focuses on managing the interest rate risk related to our mortgage assets with a bias towards minimizing our exposure to credit risk.  We believe that the best approach to generating a positive net income is to manage our liabilities in relation to the interest rate risks of our investments.  To help achieve this result, we employ financing, generally short-term, and combine our financings with various hedging techniques, such as interest rate swaps and buying and selling futures contracts.  We may, subject to maintaining our REIT qualification, also employ other hedging instruments from time to time, including interest rate caps, collars, swaptions and MBS TBA pools to protect against adverse interest rate movements.  

We focus on agency securities we identify as having short effective durations, which we believe limits the impact of changes in interest rates on the market value of our portfolio and on our net interest margin (interest income less financing costs).  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 cash distributions to shareholders over the long term.  Our manager has invested and seeks to invest in real estate mortgage assets 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 is to own assets with short durations and predictable prepayment characteristics.  Since our formation, all of our invested assets have been in agency securities, and we currently intend that the majority of our investment assets will continue to be agency securities.  These agency securities currently consist of mortgages that have principal and interest payments guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac.  We invest in both adjustable-rate and fixed-rate agency securities.  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.  All of our fixed-rate agency securities purchased to date have been 10-year and 15-year amortizing fixed rate securities.  As of March 31, 2014, our portfolio consisted of approximately $17.1 billion in market value of agency securities, consisting of $16.7 billion of adjustable rate securities and $0.5 billion of fixed rate securities.  

We purchase a substantial portion of our agency securities through delayed delivery transactions, including “to-be-announced” (“TBA”) securities.  At times when market conditions are conducive, we may choose to move the settlement of these securities out to a later date by entering into an offsetting position in the near month, which is then net settled for cash, and simultaneously entering into a similar TBA contract for a later settlement date.  Such a set of transactions is referred to as a “dollar roll” transaction.  Specified pools can also be the subject of a dollar roll transaction, when market conditions allow.  The agency securities purchased at the forward settlement date are typically priced at a discount to securities for settlement in the current month.  This difference is referred to as the “price drop.”  The price drop represents compensation to us for foregoing net interest margin and is referred to as “dollar roll income.”

The following table represents key data regarding our Company for the past twelve quarters:

As of	Agency Securities		Repurchase Agreements		Equity		Shares Outstanding		Book Value Per Share		Earnings Per Share
March 31, 2014	$	17,137,956	$	15,183,457	$	2,392,714		96,515	$	21.81	$	0.12
December 31, 2013	$	17,642,532	$	16,129,683	$	2,364,101		96,602	$	21.50	$	(0.16	)
September 30, 2013	$	19,843,830	$	18,829,771	$	2,373,641		97,909	$	21.31	$	(2.72	)
June 30, 2013	$	25,256,043	$	23,077,252	$	2,479,089		98,830	$	22.18	$	0.66
March 31, 2013	$	25,162,730	$	22,586,932	$	3,072,265		98,830	$	28.18	$	0.62
December 31, 2012	$	23,919,251	$	22,866,429	$	3,072,864		98,822	$	28.19	$	1.02
September 30, 2012	$	26,375,137	$	23,583,180	$	3,212,556		98,809	$	29.60	$	0.83
June 30, 2012	$	22,367,121	$	20,152,860	$	2,692,261		98,074	$	27.45	$	0.91
March 31, 2012	$	18,323,972	$	16,556,630	$	2,669,300		97,779	$	27.30	$	0.89
December 31, 2011	$	17,741,873	$	16,162,375	$	2,080,188		76,823	$	27.08	$	0.92
September 30, 2011	$	17,614,374	$	15,886,231	$	2,015,003		76,547	$	26.32	$	1.04
June 30, 2011	$	16,416,897	$	14,800,594	$	2,006,606		75,092	$	26.72	$	1.04

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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 margin, 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, including 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 margin 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 asset coupon rates will reprice more slowly than the corresponding liabilities used to finance those assets.  Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net interest margin.  With the maturities of our assets generally being longer term than those of our liabilities, interest rate increases will tend to decrease our net interest margin 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 these prepayments at comparable yields, our net interest margin may suffer.  The current climate of government intervention in the mortgage market 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 borrowing costs;

· our hedging activities;

· the market value of our investments; 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 Quarterly Report on Form 10-Q, and in our Annual Report on Form 10-K for the year ended December 31, 2013.  

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Market and Interest Rate Trends and the Effect on our Portfolio

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.  

Since that time, there have been a number of proposals introduced, both from industry groups and by the U.S. Congress outlining alternatives for reforming the U.S. housing system, specifically Fannie Mae and Freddie Mac, and transforming the government’s involvement in the housing market.  A recent bill in Congress that received serious consideration is the Housing Finance Reform and Taxpayer Protection Act of 2013, also known as the Corker-Warner bill.  This legislation, among other things, would eliminate Freddie Mac and Fannie Mae and replace them with a new agency which would provide a financial guarantee that would only be tapped after private institutions and investors stepped in.  In addition, on July 11, 2013, members of the U.S. House of Representatives introduced the Protecting American Taxpayers and Homeowners Act (“PATH”), a broad financing reform bill that would serve as a counterpart to the Corker-Warner bill.  PATH would also revoke the charters of Fannie Mae and Freddie Mac and remove barriers to private investment.  In the first quarter of 2014 Senators Tim Johnson (D-SD) and Mike Crapo (R-ID), the two most senior members of the Senate Banking Committee, released a proposed bill known as the Johnson-Crapo bill, which is generally based on the Corker-Warner bill. As the Federal Housing Finance Agency and both houses of Congress are each working on separate measures intended to restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac, we expect debate and discussion on the topic to continue throughout 2014.  It remains unclear whether these or any other proposals will become law or, should a proposal become law, if or how the enacted law will differ from the current draft of the bill.  It is unclear how the proposals would impact housing finance, and what impact, if any, it would have on mortgage REITs.  

U.S. Treasury and Agency Securities Market Intervention

One of the main factors impacting market prices of our investments has been the U.S. Federal Reserve’s programs to purchase U.S. Treasury and agency securities in the open market.  These programs, referred to as “quantitative easing” are aimed to improve the employment outlook and increase growth in the U.S. economy.  The third round of these purchases, commonly referred to as “QE3” was announced in September 2012.  One effect of these purchases has been an increase in the prices of agency securities, which has contributed to the decrease of our net interest margin.  On December 18, 2013, the U.S. Federal Reserve announced that it would reduce its purchases of both agency securities and U.S. Treasury securities by $5 billion each for the month of January.  On January 29, 2014, the U.S. Federal Reserve announced additional $5 billion reductions to its monthly purchase of both agency securities and U.S. Treasury securities to take effect in February 2014, and on March 19, 2014, it announced a further reduction, bringing the current purchases for April down to $25 billion agency securities and $30 billion of U.S. Treasury securities. In March 2014, the U.S. Federal Reserve also stated it would continue reinvesting principal payments from its agency securities and rolling over maturing U.S. Treasury securities at auction.  The announcements on the tapering of the U.S. Federal Reserve’s purchases drove interest rates higher on U.S. Treasury and agency securities and resulted in large negative price movements in our assets.  The unpredictability and size of these programs has also injected additional volatility into the pricing and availability of our assets.  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 additional price declines.  

Regulatory Concerns

We believe that we conduct our business in a manner that allows us to avoid being regulated as an investment company under the Investment Company Act pursuant to the exemption provided by Section 3(c)(5)(C) for entities that are primarily engaged in the business of purchasing or otherwise acquiring “mortgages and other liens on and interests in real estate.” On August 31, 2011, the SEC issued a concept release (No.  IC-29778; File No.  SW7-34-11, Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related Instruments) pursuant to which it is reviewing whether certain companies that invest in MBS and rely on the exemption from registration under Section 3(c)(5)(C) of the Investment Company Act (such as us) should continue to be allowed to rely on such exemption from registration.  If we fail to continue to qualify for this exemption from registration as an investment company, or the SEC determines that companies that invest in MBS are no longer able to rely on this exemption, our ability to use leverage would be substantially reduced and we would be unable to conduct our business as planned, or we may be required to register as an investment company under the Investment Company Act, either of which could negatively affect the value of shares of our common stock and our ability to make distributions to our shareholders.  

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

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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.  

The Dodd-Frank Act established the Office of Financial Research within the Treasury Department to improve the quality of financial data available to policymakers and to facilitate more robust and sophisticated analysis of the financial system.  This analysis may also include the scrutiny of mortgage REITs for potential systematic risk.  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 were subject to individual adoption by member nations, including the United States by January 1, 2013.  As of September 2013, the majority of participating countries had formally adopted most provisions of Basel III, with implementations generally beginning January 1, 2014.  It is unclear how the adoption of Basel III will affect our business at this time, however, as capital charges increase for banks we may see an increase in our borrowing costs.  

Exposure to European Financial Counterparties

We have no direct exposure to any European sovereign credit.  We do finance the acquisition of our agency securities with repurchase agreements, some of which are provided by European banks.  In connection with these financing arrangements, we pledge our securities as collateral to secure the borrowing.  The amount of collateral pledged will typically exceed the amount of the financing with the extent of over-collateralization ranging from 3%-6% of the amount borrowed.  While repurchase agreement financing results in us recording a liability to the counterparty in our consolidated balance sheet, we are exposed to the counterparty, if during the term of the repurchase agreement financing, a lender should default on its obligation and we are not able to recover our pledged assets.  The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral.  

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In addition, we use interest rate swaps to manage interest rate risk exposure in connection with our repurchase agreement financings.  We will make cash payments or pledge securities as collateral as part of a margin arrangement in connection with interest rate swaps that are in an unrealized loss position.  In the event that a counterparty were to default on its obligation, we would be exposed to a loss to a swap counterparty to the extent that the amount of cash or securities pledged exceeded the unrealized loss on the associated swaps and we were not able to recover the excess collateral.  

During the past several years, several large European banks have experienced financial difficulty and have been either rescued by government assistance or by other large European banks.  Some of these banks have U.S. banking subsidiaries, which have provided financing to us, particularly repurchase agreement financing for the acquisition of agency securities.  At March 31, 2014, we had entered into repurchase agreements and/or interest rate swaps with seven financial institution counterparties that are either domiciled in Europe or a U.S.-based subsidiary of a European domiciled financial institution.  Our total exposure to these banks was 7.8% of our equity at March 31, 2014.  At March 31, 2014, we did not use credit default swaps or other forms of credit protection to hedge these exposures, although we may in the future.  The following table shows our exposure by country to European banks.  

	Number of Counterparties		Exposure (1)		Exposure as a Percentage of Equity
England		1	$	26,133		1.1	%
France		1	$	27,958		1.2	%
Germany		2	$	25,398		1.0	%
Netherlands		1	$	40,900		1.7	%
Scotland		1	$	19,183		0.8	%
Switzerland		1	$	46,669		2.0	%
		7	$	186,241		7.8	%

⁽¹⁾ Exposure represents our total assets pledged as collateral in excess of our obligations, including any accrued interest receivable on the pledged assets.  

If the European credit crisis continues to impact these major European banks, there is the possibility that it will also impact the operations of their U.S. banking subsidiaries.  This could adversely affect our financing and operations as well as those of the entire mortgage sector in general.  Management monitors our exposure to our repurchase agreement and swap counterparties on a regular basis, using various methods, including review of recent rating agency actions or other developments and by monitoring the amount of cash and securities collateral pledged and the associated loan amount under repurchase agreements and/or the fair value of swaps with our counterparties.  We intend to make reverse margin calls on our counterparties to recover excess collateral as permitted by the agreements governing our financing arrangements, or take other necessary actions to reduce the amount of our exposure to a counterparty when such actions are considered necessary.  

Interest Rates

Mortgage markets in general, and our strategy in particular, are interest rate sensitive.  The relationship between several interest rates is generally determinant of the performance of our company.  Our borrowings in the repurchase market have historically closely tracked LIBOR and the U.S. Federal Funds Effective Rate.  Significant volatility in these rates or a divergence from the historical relationship among these rates could negatively impact our ability to manage our portfolio.  The agency securities we buy are affected by the shape of the yield curve, particularly along the area between two year Treasury rate and 10 year Treasury rates.  The following table shows the 30-day LIBOR as compared to these rates at each period end for the past twelve quarters:

	30-  DayLIBOR			Fed Funds Effective Rate			Two Year Treasury			10 Year Treasury
March 31, 2014		0.15	%		0.06	%		0.44	%		2.73	%
December 31, 2013		0.17	%		0.07	%		0.38	%		3.04	%
September 30, 2013		0.18	%		0.06	%		0.33	%		2.64	%
June 30, 2013		0.19	%		0.07	%		0.36	%		2.49	%
March 31, 2013		0.20	%		0.09	%		0.24	%		1.85	%
December 31, 2012		0.21	%		0.09	%		0.25	%		1.78	%
September 30, 2012		0.21	%		0.09	%		0.23	%		1.63	%
June 30, 2012		0.25	%		0.09	%		0.30	%		1.65	%
March 31, 2012		0.24	%		0.09	%		0.33	%		2.21	%
December 31, 2011		0.30	%		0.04	%		0.24	%		1.88	%
September 30, 2011		0.24	%		0.06	%		0.25	%		1.92	%
June 30, 2011		0.19	%		0.07	%		0.46	%		3.16	%

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Principal Repayment Rate

Our net income is primarily a function of the difference between the yield on our assets and the financing cost of owning those assets.  Since we tend to purchase assets at a premium to par, the main 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.  Estimates of repayment rates are critical to 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, the yields which those new securities may add to our portfolio, as well as the extent to which we extend the duration of our liabilities in connection with hedging activities.  

The following table shows the weighted average principal repayment rate and the one-month constant prepayment rate (“CPR”) for the last twelve quarters:

	Weighted Average Principal Repayment Rate (1)			Weighted Average Principal Repayment RateAnnualized (2)			One Month CPR (3)
March 31, 2014		4.42	%		17.66	%		13.0
December 31, 2013		4.89	%		19.55	%		14.2
September 30, 2013		6.93	%		27.72	%		19.7
June 30, 2013		7.03	%		28.10	%		20.8
March 31, 2013		6.50	%		26.01	%		19.0
December 31, 2012		6.64	%		26.55	%		19.8
September 30, 2012		6.90	%		27.61	%		20.5
June 30, 2012		6.36	%		25.42	%		19.7
March 31, 2012		6.42	%		25.67	%		19.6
December 31, 2011		6.85	%		27.39	%		20.8
September 30, 2011		7.14	%		28.55	%		21.7
June 30, 2011		4.64	%		18.54	%		14.9

⁽¹⁾ Scheduled and unscheduled principal payments as a percentage of the weighted average portfolio.  

⁽²⁾ Weighted average principal repayment rate annualized.  

⁽³⁾ CPR measures one month of unscheduled repayments as a percentage of principal on an annualized basis.  

Book Value per Share

As of March 31, 2014, our book value per share of common stock (total shareholders’ equity less the aggregate liquidation preference for Series A Preferred Stock divided by shares of common stock outstanding) was $21.81, an increase of $0.31, from $21.50 at December 31, 2013.  The increase in our book value was primarily a result of the increase in the unrealized gain on our assets partially offset by the impact of dividends declared in excess of GAAP earnings.  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
March 31, 2014	$	25.31		(4.11	)		1.50			(0.89	)	$	21.81
December 31, 2013	$	25.30		(3.72	)		1.07			(1.15	)	$	21.50
September 30, 2013	$	25.19		(3.02	)		0.53			(1.39	)	$	21.31
June 30, 2013	$	25.16		0.26			(1.91	)		(1.33	)	$	22.18
March 31, 2013	$	25.15		0.30			4.94			(2.21	)	$	28.18
December 31, 2012	$	25.15		0.38			5.12			(2.46	)	$	28.19
September 30, 2012	$	25.14		0.05			7.16			(2.75	)	$	29.60
June 30, 2012	$	25.25		0.02			4.73			(2.55	)	$	27.45
March 31, 2012	$	25.23		0.01			4.29			(2.23	)	$	27.30
December 31, 2011	$	24.79		0.03			5.11			(2.85	)	$	27.08
September 30, 2011	$	24.79		0.01			4.56			(3.04	)	$	26.32
June 30, 2011	$	24.79		(0.03	)		3.47			(1.51	)	$	26.72

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Investments

We invest in both adjustable and fixed-rate agency securities.  At March 31, 2014 and December 31, 2013, we owned $17.1 billion and $17.6 billion, respectively, of agency securities.  While our strategy focuses on ARM securities, we also own fixed-rate securities with estimated durations that we believe are beneficial to the overall mix of our assets.  As of March 31, 2014 and December 31, 2013, our agency securities portfolio was purchased at a net premium to par, or face value, with a weighted-average amortized cost of 102.84 and 102.87, respectively, of face value.  As of March 31, 2014 and December 31, 2013, we had approximately $469.2 million and $488.9 million, respectively, of unamortized premium included in the cost basis of our agency securities.  

During the quarter ended March 31, 2014, we purchased approximately $1.3 billion of agency securities with a weighted average coupon of 2.83%.  We also sold approximately $578.6 million of agency securities with a weighted average coupon of 3.4%.    During the quarter ended March 31, 2013, we purchased approximately $3.5 billion of agency securities with a weighted average coupon of 2.27%

We typically want to own a higher percentage of Fannie Mae ARMs than Freddie Mac ARMs as Fannie Mae has better cash flow to the security holder because Fannie Mae pays principal and interest sooner after accrual (54 days) as compared to Freddie Mac (75 days).  

Our investment portfolio consisted of the following types of Fannie Mae, Freddie Mac and Ginnie Mae securities at March 31, 2014:

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value		% of Total
Agency Securities
Fannie Mae Certificates
ARMs	$	9,553,321	$	(36,442	)	$	171,484	$	9,688,363		56.5	%
Fixed Rate		303,611		(345	)		817		304,083		1.8	%
Total Fannie Mae		9,856,932		(36,787	)		172,301		9,992,446
Freddie Mac Certificates
ARMs		6,964,182		(54,734	)		63,071		6,972,519		40.7	%
Fixed Rate		173,086		(196	)		101		172,991		1.0	%
Total Freddie Mac		7,137,268		(54,930	)		63,172		7,145,510
Total Agency Securities	$	16,994,200	$	(91,717	)	$	235,473	$	17,137,956

As of December 31, 2013, our investment portfolio consisted of the following types of securities:

	Amortized Cost		Gross Unrealized Loss			Gross Unrealized Gain		Estimated Fair Value		% of Total
Agency Securities
Fannie Mae Certificates
ARMs	$	9,620,743	$	(44,871	)	$	167,848	$	9,743,720		55.2	%
Fixed Rate		806,312		(1,798	)		3,832		808,346		4.6	%
Total Fannie Mae		10,427,055		(46,669	)		171,680		10,552,066
Freddie Mac Certificates
ARMs		6,671,013		(70,752	)		57,808		6,658,069		37.8	%
Fixed Rate		338,738		(1,600	)		21		337,159		1.9	%
Total Freddie Mac		7,009,751		(72,352	)		57,829		6,995,228
Ginnie Mae Certificates
ARMs		-		-			-		-		0.0	%
Fixed Rate		96,236		(998	)		-		95,238		0.5	%
Total Ginnie Mae		96,236		(998	)		-		95,238
Total Agency Securities	$	17,533,042	$	(120,019	)	$	229,509	$	17,642,532

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Adjustable-rate securities

As of March 31, 2014 our investment portfolio consisted of ARM securities as follows:

Months to Reset	% of ARM Portfolio			Current Face Value (1)		Weighted Avg. Coupon (2)			Wtd. Avg. Amortized Purchase Price (3)		Amortized Cost (4)		Weighted Avg. Market Price (5)		Market Value (6)
0-12		8.7	%	$	1,368,577		3.30	%	$	101.82	$	1,393,433	$	106.35	$	1,455,467
13-24		12.9	%		2,030,467		3.24	%	$	102.58		2,082,900	$	105.70		2,146,155
25-36		12.5	%		1,992,070		2.75	%	$	102.61		2,044,075	$	104.53		2,082,309
37-48		15.4	%		2,467,224		2.93	%	$	102.78		2,535,811	$	104.30		2,573,318
49-60		20.9	%		3,369,578		2.72	%	$	102.87		3,466,190	$	103.15		3,475,606
61-72		20.8	%		3,399,282		2.38	%	$	103.34		3,512,700	$	101.72		3,457,582
73-84		8.8	%		1,440,849		2.61	%	$	102.72		1,480,028	$	101.89		1,468,053
109-120		0.0	%		2,351		3.13	%	$	100.64		2,366	$	101.74		2,392
Total ARMs		100.0	%	$	16,070,398		2.79	%	$	102.78	$	16,517,503	$	103.67	$	16,660,882

As of December 31, 2013, our investment portfolio consisted of ARM securities as follows:

Months to Reset	% of ARM Portfolio			Current Face Value (1)		Weighted Avg. Coupon (2)			Wtd. Avg. Amortized Purchase Price (3)		Amortized Cost (4)		Weighted Avg. Market Price (5)		Market Value (6)
0-12		7.5	%	$	1,165,714		3.15	%	$	101.77	$	1,186,380	$	106.10	$	1,236,878
13-24		9.8	%		1,526,598		3.49	%	$	102.30		1,561,668	$	105.73		1,614,081
25-36		14.2	%		2,212,306		2.99	%	$	102.45		2,266,557	$	104.96		2,321,985
37-48		15.4	%		2,430,716		2.73	%	$	102.77		2,498,130	$	103.88		2,524,939
49-60		15.1	%		2,394,168		2.94	%	$	102.58		2,455,924	$	103.72		2,483,318
61-72		29.0	%		4,664,901		2.46	%	$	103.31		4,819,437	$	101.83		4,750,098
73-84		9.0	%		1,461,452		2.44	%	$	102.89		1,503,660	$	100.62		1,470,490
Total ARMs		100.0	%	$	15,855,855		2.80	%	$	102.75	$	16,291,756	$	103.44	$	16,401,789

⁽¹⁾ The current face is the current monthly remaining dollar amount of principal of a mortgage security.  We compute current face 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.  

⁽⁶⁾ Market value is the total market value for the mortgage security.  

As of March 31, 2014, excluding any fixed-rate securities, the ARMs underlying our adjustable rate agency securities had fixed interest rates for an average period of approximately 46 months after which time the interest rates reset and become adjustable annually.  At March 31, 2014, 96.7% of our agency ARMs were still in their initial fixed-rate period and 3.3% of our agency ARMs have already reached their initial reset period and will reset annually for the life of the security.  At March 31, 2014, an additional 5.4% of our agency ARMs will reach the end of their initial fixed-rate period in the next 12 months.  

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

31

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.  

Fixed-rate securities

In addition to adjustable-rate securities, we also invest in fixed-rate securities.  All of our fixed-rate agency securities purchased to date have been 10-year and 15-year amortizing fixed rate securities.  At March 31, 2014, we owned $477.1 million of 15-year fixed-rate agency securities with a weighted average life, assuming a constant prepayment rate of 10, of 4.1 years.  The following table details our fixed rate portfolio at March 31, 2014.  

Wtd. Avg Months to Maturity	% of Fixed Rate Portfolio			Current Face Value (1)		Weighted Avg. Coupon (2)			Wtd. Avg. Amortized Purchase Price (3)		Amortized Cost (4)		Weighted Avg. Market Price (5)		Market Value (6)
133-144		57.4	%	$	260,500		3.50	%	$	104.84	$	273,120	$	105.04	$	273,626
145-156		42.6	%		194,105		3.50	%	$	104.88		203,577	$	104.81		203,448
Total Fixed Rate		100.0	%	$	454,605		3.50	%	$	104.86	$	476,697	$	104.94	$	477,074

The following table details our fixed rate portfolio at December 31, 2013.  

Wtd. Avg Months to Maturity	% of Fixed Rate Portfolio			Current Face Value (1)			Weighted Avg. Coupon (2)			Wtd. Avg. Amortized Purchase Price (3)			Amortized Cost (4)			Weighted Avg. Market Price (5)			Market Value (6)
133-144		6.1	%		$	72,252		3.50	%		$	105.40		$	76,154		$	104.76		$	75,693
145-156		38.5	%			456,585		3.50	%		$	104.82			478,592		$	104.59			477,544
157-168		7.7	%			93,198		3.00	%		$	103.26			96,237		$	102.19			95,238
169-180		47.7	%			566,299		3.50	%		$	104.24			590,303		$	104.59			592,268
Total Fixed Rate		100.0	%		$	1,188,334		3.46	%		$	104.46		$	1,241,286		$	104.41		$	1,240,743

⁽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 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.  

⁽⁶⁾ Market value is the total market value for the mortgage security.  

Forward Purchases

While most of our purchases of agency securities are accounted for using trade date accounting, some forward purchases, such as certain TBA contracts, do not qualify for trade date accounting and are considered derivatives for financial statement purposes.  Pursuant to Accounting Standards Codification Topic 815, Derivatives and Hedging, 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.  If the Company intends to take physical delivery of the security, the commitment is designated as an all-in-one cash flow hedge and its unrealized gains and losses are recorded in other comprehensive income.  If the Company does not intend to take physical delivery, as is the case with TBA dollar rolls, the commitment is not designated as an accounting hedge and unrealized gains and losses are recorded in “Gain (loss) on derivative instruments, net.”

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The following table shows the ARM TBA contracts at March 31, 2014 and December 31, 2013.

	Face		Cost		Fair Market Value		Net Asset
March 31, 2014	$	70,000	$	71,839	$	72,040	$	201
December 31, 2013	$	-	$	-	$	-	$	-

The following table shows our 15-year TBA dollar roll contracts at March 31, 2014 and December 31, 2013.

	Face		Coupon		Cost		Fair Market Value		Net Asset (Liability)
March 31, 2014	$	3,400,000		3.4%	$	3,565,399	$	3,551,765	$	(13,634	)
December 31, 2013	$	600,000		3.5%	$	632,270	$	627,187	$	(5,083	)

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 March 31, 2014, we had established 30 borrowing relationships with various investment banking firms and other lenders.  We had an outstanding balance under our repurchase agreements at March 31, 2014 of $15.2 billion with 25 counterparties.  We had an outstanding balance of $16.1 billion at December 31, 2013 with 25 different counterparties.  

Hedging Instruments

We generally intend to hedge, on an economic basis, 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;

· fair value accounting rules could foster adverse valuation adjustments due to credit quality considerations that could impact both earnings and shareholder equity;

· 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, and in the case of derivatives not subject to hedge accounting, our earnings as well.  

As of March 31, 2014, we had entered into 73 interest rate swap agreements with 13 counterparties to hedge (on an economic basis) a benchmark interest rate – LIBOR.  This portfolio of hedges is designed to lock in funding costs for specific funding activities associated with specific assets as a way to realize attractive net interest margins.  This hedging strategy incorporates an assumed prepayment schedule, which, if not realized, will cause our 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 $10.1 billion of borrowings under our repurchase agreements.  We also purchase Eurodollar Futures Contracts (“Futures Contracts”), which are based on three-month LIBOR, as part of our strategy to mitigate interest rate risk.  The effective notional amounts and rates of our interest rate swaps and Futures Contracts as of March 31, 2014 were as follows:

33

	Futures Contracts		Futures Contracts Rate			Swap Notional		Swap Rate			Total		Weighted-Average Rate
Effective 2014	$	1,675,000		0.33	%	$	9,066,667		1.33	%	$	10,741,667		1.18	%
Effective 2015		7,089,500		0.99	%		5,825,000		1.28	%		12,914,500		1.12	%
Effective 2016		6,677,750		2.01	%		3,100,000		0.71	%		9,777,750		1.60	%
Effective 2017		6,102,750		2.98	%		850,000		0.90	%		6,952,750		2.73	%
Effective 2018		3,716,500		3.70	%		50,000		0.96	%		3,766,500		3.67	%
Effective 2019		770,250		4.15	%		-		-			770,250		4.15	%
Effective 2020		272,250		4.38	%		-		-			272,250		4.38	%
Effective 2021		45,250		4.46	%		-		-			45,250		4.46	%

If the rates on our repurchase agreements do not move in tandem with LIBOR, we will be less effective at fixing this cost and our results will differ from expectations.  

On September 30, 2013, we discontinued hedge accounting for our interest rate swap agreements by de-designating the swaps as cash flow hedges.  No swaps were terminated in conjunction with this action, and our risk management and hedging practices are unimpacted.  However, our accounting for these transactions was changed prospectively effective October 1, 2013.  All of our swaps had previously been accounted for as cash flow hedges under ASC Topic 815, Derivatives and Hedging.  As a result of discontinuing hedge accounting, beginning October 1 changes in the fair value of our interest rate swap agreements are recorded in “Gain (loss) on derivative instruments, net” in our consolidated statements of income, rather than in other comprehensive income.  Also, net interest paid or received under the swaps, which up through September 30 was recognized in “interest expense,” is now recognized in “Gain (loss) on derivative instruments, net.”

New Business Initiatives

We are currently exploring the possibility of acquiring and aggregating individual whole jumbo mortgage loans, with a goal of securitizing the loans into MBS not guaranteed by a U.S. Government sponsored entity or a U.S. Government agency.  We would expect to retain initially all or a majority of the MBS.  In connection with this initiative, we may enter into arrangements whereby we agree with parties to acquire the loans that they originate consistent with our guidelines.  We do not anticipate that the individual mortgage loans and any resulting MBS would constitute a significant portion of our assets in the near future.

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Summary Financial Data

This table includes non-GAAP financial measures.  See the section on non-GAAP measures under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for important information about these non-GAAP measures and reconciliations to the most comparable GAAP measures.

	(Unaudited) Three Months Ended March 31
	2014			2013
Statement of Income Data
Interest income on mortgage-backed securities	$	96,307		$	124,241
Interest income on short-term cash investments		282			442
Interest expense		(38,451	)		(53,277	)
Net interest margin		58,138			71,406
Operating expenses		(7,161	)		(6,718	)
Other income (loss):
Net realized gain (loss) on sale of mortgage-backed securities		7,436			2,500
Impairment of mortgage-backed securities		-			-
Loss on derivative instruments, net		(41,615	)		51
Total other income (loss)		(34,179	)		2,551
Net income (loss)		16,798			67,239
Dividends on preferred stock		(5,480	)		(5,480	)
Net income (loss) available to common shareholders	$	11,318		$	61,759
Earnings (loss) per share of common stock, basic and diluted	$	0.12		$	0.62
Weighted average shares outstanding, basic and diluted		96,606,081			98,827,587
Distributions per common share	$	0.50		$	0.70
Selected Balance Sheet Data
Mortgage-backed securities	$	17,137,956		$	25,162,730
Total assets	$	17,965,255		$	26,098,861
Repurchase agreements and dollar roll liability	$	15,183,457		$	22,586,932
Shareholders' equity	$	2,392,714		$	3,072,265
Key Statistics  (1)
Average MBS	$	17,328,195		$	24,126,341
Average debt  (2)	$	15,787,282		$	22,342,818
Average equity	$	2,437,624		$	3,066,197
Average portfolio yield  (3)		2.22	%		2.06	%
Average cost of funds  (4)		0.97	%		0.95	%
Interest rate spread  (5)		1.25	%		1.11	%
TBA dollar roll income	$	20,821		$	-
Average TBA dollar roll position	$	3,151,215		$	-
Average portfolio yield, including TBA dollar roll income  (6)		2.29	%		2.06	%
Effective interest expense  (7)	$	43,179		$	53,277
Effective cost of funds  (7)		1.09	%		0.95	%
Effective net interest margin  (8)	$	74,231		$	71,406
Effective interest rate spread  (9)		1.20	%		1.11	%
Core earnings  (10)	$	61,590		$	59,208
Core earnings per share, basic and diluted  (10)	$	0.64		$	0.60
Constant Prepayment Rate (CPR)		13.0			19.0
Average annual portfolio repayment rate  (11)		17.66	%		26.01	%
Debt to equity (at period end) (12)	6.3:1			7.4:1
Debt to paid-in capital (at period end)  (13)	5.6:1			8.1:1
Effective debt to equity (at period end) (14)	7.7:1			7.4:1

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⁽¹⁾ The averages presented herein are computed from our books and records, using daily weighted values.  Percentages are annualized, as appropriate.

⁽²⁾ Average debt includes borrowings under repurchase agreements and dollar roll liability as presented on the consolidated balance sheets.  It does not include off-balance sheet financing related to the Company’s TBA dollar roll position.

⁽³⁾ Average portfolio yield was calculated by dividing our interest income on MBS, net of amortization, by our average MBS.

⁽⁴⁾ Average cost of funds was calculated by dividing our total interest expense (including hedges) by the sum of our average balance outstanding under our repurchase agreements and our average dollar roll liability for the period.

⁽⁵⁾ Interest rate spread was calculated by subtracting our average cost of funds from our average portfolio yield.

⁽⁶⁾ Average portfolio yield, including TBA dollar roll income was calculated the same as average portfolio yield other than to include TBA dollar roll income in the numerator and our average TBA dollar roll position in the denominator.

⁽⁷⁾ Effective interest expense includes certain interest rate swap adjustments.  Effective cost of funds is effective interest expense for the period divided by average repurchase agreements and dollar roll liability for the period.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for more information, including reconciliations for the periods presented.

⁽⁸⁾ Effective net interest margin includes certain interest rate swap adjustments and TBA dollar roll income.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for more information including reconciliations for the periods presented.

⁽⁹⁾ Effective interest rate spread was calculated by subtracting our effective cost of funds from our average portfolio yield including TBA dollar roll income.

⁽¹⁰⁾ Core earnings was calculated by subtracting operating expenses and dividends on preferred stock from effective interest margin.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for more information, including reconciliations for the periods presented.

⁽¹¹⁾ Our average annual portfolio repayment rate was calculated by dividing our total principal payments received during the year (scheduled and unscheduled) by our average MBS.

⁽¹²⁾ Our debt to equity ratio was calculated by dividing the amounts outstanding under our repurchase agreements and dollar roll liability at period end by our shareholders’ equity at period end.

⁽¹³⁾ Our debt to paid-in capital ratio was calculated by dividing the amounts outstanding under our repurchase agreements and dollar roll liability at period end by the sum of the carrying value of our preferred stock, the par value of our common stock and additional paid in capital at period end.

⁽¹⁴⁾ Our effective debt to equity ratio was calculated the same as our debt to equity ratio other than to include our off-balance sheet TBA dollar roll liability at period end in the numerator.  Our off-balance sheet TBA dollar roll liability was $3,159,801 and $0 as of March 31, 2014 and 2013, respectively.

Results of Operations

Use of GAAP and Non-GAAP Measures

In addition to our results presented in accordance with GAAP, the discussions of our results of operations and liquidity and capital resources include certain non-GAAP financial information, including presentations new this year.  We present these non-GAAP measures largely because of three developments during 2013: 1) our cessation of hedge accounting for our interest rates swaps effective September 30, 2013, as discussed elsewhere in this filing, 2) increased use of Futures Contracts as interest rate hedges, and 3) our use of dollar roll transactions, which generate non-traditional investment income and embody off-balance sheet financing.   These changes result in the recognition of material fair value adjustments in net income, as well as line item classifications that our management believes make it difficult to explain fully the economics of our results and strategies without supplemental disclosures.   The non-GAAP measures we employ are effective interest expense, effective net interest margin, core earnings and core earnings per share, and financial metrics derived from these non-GAAP measures, such as effective cost of funds and effective leverage.  We use these measures internally to assess our results and financial condition.  Therefore, we believe that providing these measures gives users of financial information additional clarity regarding our performance and financial condition and better enables them to see “through the eyes of management.”

We define effective interest expense as our interest expense determined in accordance with GAAP, adjusted to exclude reclassification of deferred swap losses included in interest expense subsequent to our termination of hedge accounting, to include interest rate swap monthly net settlements subsequent to our termination of hedge accounting, and to include swap equivalent gains and losses related to our Futures Contracts.  

We similarly define effective net interest margin as our net interest margin determined in accordance with GAAP, adjusted to exclude reclassification of deferred swap losses included in interest expense subsequent to our termination of hedge accounting, to include interest rate swap monthly net settlements subsequent to our termination of hedge accounting, to include swap equivalent gains and losses related to our Futures Contracts, and to include TBA dollar roll income.  

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We define core earnings as our effective net interest margin (as defined above) further adjusted to deduct operating expenses and dividends on preferred stock.  

Our interest expense and net interest margin determined in accordance with GAAP reflect monthly cash settlement under our interest rate swap agreements until September 30, 2013, but not thereafter.  We believe that our presentation of effective interest expense, effective net interest margin and core earnings, all of which adjust for this difference after September 30, 2013, provide a better basis for comparison between 2014 and 2013.  

We define our average cost of funds as our total net interest expense (including hedges) determined in accordance with GAAP divided by our average balance outstanding under our repurchase agreements and dollar roll liability computed from our books and records, using daily weighted values.  Similarly, we define effective cost of funds as our total effective interest expense divided by our average balance outstanding under our repurchase agreements and dollar roll liabilities computed from our books and records, using daily weighted values.  

These measures involve differences from results computed in accordance with GAAP, and should be considered supplementary to, and not as a substitute for, our results computed in accordance with GAAP.  None of the non-GAAP measures we present represents cash provided by operating activities determined in accordance with GAAP, and none is a measure of liquidity or an indicator of our ability to pay cash dividends.  Further, our definitions of these non-GAAP measures may not be comparable to similarly-titled measures of other companies.  Reconciliations of each non-GAAP measure to its nearest directly comparable measure calculated in accordance with GAAP are included below.  

Please see “Summary Financial Data” above for definitions of other metrics we use below, including average portfolio yield and average annual portfolio repayment rate.  

Overview

Our results for 2014 and 2013 have been largely dominated by U.S. Federal Reserve actions, primarily the discussion around the timing of the end of its quantitative easing program and the beginning of increases in the Fed Funds Target Rate.  Speculation on the nearness and pace of these events has steepened the yield curve and consequently significantly slowed home loan refinancing.  This has both positive and negative effects on our results, but on balance it is a more favorable operating environment than we saw for much of 2013.  

Our summarized results of operations for the three month periods ended March 31, 2014 and 2013, along with related key metrics, were as follows:

Net Income

	Three Months Ended March 31
	2014			2013			Change
Statement of Income Data
Total interest income	$	96,589		$	124,683			-23	%
Interest expense		(38,451	)		(53,277	)		-28	%
Net interest margin		58,138			71,406			-19	%
Operating expenses		(7,161	)		(6,718	)		7	%
Other income (loss):
Net realized gain (loss) on sale of mortgage-backed securities		7,436			2,500			197	%
Impairment of mortgage-backed securities		-			-		NM
Gain (loss) on derivative instruments, net		(41,615	)		51		NM
Total other income (loss)		(34,179	)		2,551		NM
Net income		16,798			67,239			-75	%
Dividends on preferred stock		(5,480	)		(5,480	)		0	%
Net income available to common shareholders	$	11,318		$	61,759			-82	%
Earnings per share of common stock, basic and diluted	$	0.12		$	0.62			-81	%

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	Three Months Ended March 31
	2014		2013		Change
Core earnings	$	61,590	$	59,208		4	%
Core earnings per share, basic and diluted	$	0.64	$	0.60		6	%
Weighted average shares outstanding		96,606,081		98,827,587		-2	%

1Q14 vs. 1Q13

Net income declined due primarily to:

— Lower other income, primarily due to net realized and unrealized losses on derivative instruments; and

— Lower net interest margin, driven by the lower average size of our mortgage-backed securities portfolio and corresponding lower average leverage.

Core earnings increased due primarily to:

— Higher effective net interest margin, driven by higher average portfolio yield stemming from:

o Lower premium amortization on lower portfolio prepayments; and

o Incremental yield from our TBA dollar roll position in excess of the yield that would have been achieved had we invested in similar securities financed with repurchase agreements.

Each of these factors is discussed further below.

Total Interest Income

	Three Months Ended March 31
	2014			2013			Change
Coupon interest on MBS and short-term investments	$	118,680		$	167,876			-29%
Net premium amortization		(22,091	)		(43,193	)		49%
Total interest income	$	96,589		$	124,683			-23%
Average MBS	$	17,328,195		$	24,126,341			-28%
Weighted-average coupon on MBS		2.81	%		2.86	%		-2%
Average portfolio yield		2.22	%		2.06	%		8%
Average annual portfolio repayment rate		17.66	%		26.01	%		-32%

The major drivers of our interest income are the coupons on the securities we own, the size of our portfolio, and the rate of principal repayments.  The following are key components of the change between periods:

1Q14 vs. 1Q13

Total interest income decreased due primarily to:

— The lower average size of our mortgage-backed securities portfolio; and

— The decrease in the weighted-average coupon of our portfolio.

These declines were partially offset by:

— A lower rate of premium amortization driven by lower prepayments on our portfolio.

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Interest Expense

	Three Months Ended March 31
	2014			2013			Change
Repurchase agreements and dollar roll liability	$	13,699		$	23,142			-41	%
Swaps settlements and amortization		68			30,135			-100	%
Reclassification of deferred hedge loss		24,684			-		NM
Interest expense	$	38,451		$	53,277			-28	%
Effective interest expense	$	43,179		$	53,277			-19	%
Average debt	$	15,787,282		$	22,342,818			-29	%
Average rate on debt		0.35	%		0.41	%		-15	%
Average cost of funds		0.97	%		0.95	%		2	%
Effective cost of funds		1.09	%		0.95	%		15	%

The costs of financing we incur are primarily affected by the amount of our borrowings, the interest rates on those borrowings and the degree to which we hedge those rates.  Note that our cessation of hedge accounting for our interest rate swaps caused changes in the classification of monthly swaps settlements and changes in fair value, effective October 1, 2013.  The following are key components of the change between periods:

1Q14 vs. 1Q13

Interest expense decreased due primarily to:

· The decrease in our average debt, as a result of lower average leverage in light of the prospect of rising interest rates; and

· The lower average rate on our debt (primarily repurchase agreements);

· Partially offset by higher average cost of funds driven by the reclassification adjustments related to our deferred hedge loss, which does not vary with our average debt balance.

Effective interest expense decreased due primarily to:

· Lower average debt partially offset by the higher effective costs of funds, driven by a higher hedge ratio.

Net Interest Margin and Interest Rate Spread

	Three Months Ended March 31
	2014			2013			Change
Net interest margin	$	58,138		$	71,406			-19%
Effective net interest margin	$	74,231		$	71,406			4%
Average portfolio yield		2.22	%		2.06	%		0.16%
Average cost of funds		0.97	%		0.95	%		0.02%
Average interest rate spread		1.25	%		1.11	%		0.14%
Average portfolio yield, including TBA dollar roll income		2.29	%		2.06	%		0.23%
Effective cost of funds		1.09	%		0.95	%		0.14%
Effective interest rate spread		1.20	%		1.11	%		0.09%

The most important metric of our earnings power is our net interest margin, or our “spread” when referred to in percentage form.  Our spread and our leverage largely indicate our ability to earn distributable income.  Our interest rate spread increased versus the preceding period.  See the discussions of Total Interest Income and Interest Expense above for the key drivers of these changes.

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Other Income (Loss)

	Three Months Ended March 31
	2014			2013		Change
Other income (loss):
Net realized gain (loss) on sale of mortgage-backed securities	$	7,436		$	2,500		197%
Impairment of mortgage-backed securities		-			-	NM
Gain (loss) on derivative instruments, net		(41,615	)		51	NM
Total other income (loss)	$	(34,179	)	$	2,551	NM

Our other income generally consists of realized gains and losses on our MBS investments and realized and unrealized gains and losses on derivative instruments.  Earnings related to these areas tend to be uneven, as can be seen in the table above.

1Q14 vs. 1Q13

Other income (loss) swung to a loss for the following reasons:

· In 2013, we began using Eurodollar Futures Contracts as part of our hedging strategy.  Net realized and unrealized losses on these contracts were $(35,988) for 1Q14 and are reflected in “Gain (loss) on derivative instruments, net.”  In 1Q13, our hedging was done exclusively via interest rate swaps, with unrealized gains and losses recorded to “other comprehensive income,” in accordance with hedge accounting.

· Effective September 30, 2013, we de-designated our interest rate swaps as cash flow hedges for accounting purposes.  As a result, from October 1, 2013 forward, monthly swap settlements and the change in fair value of our swaps, which amounted to a net loss of $(13,549) for 1Q14, were recorded to “Gain (loss) on derivative instruments, net.”

These declines were partially offset by:

· Our TBA dollar roll positions generated a net gain of $7,922 in 1Q14, consisting of realized and unrealized losses of $(12,899) and TBA dollar income of $20,821, both of which are reflected in “Gain (loss) on derivative instruments, net.” We did not begin utilizing dollar rolls until 4Q13.

Operating Expenses

	Three Months Ended March 31
	2014			2013			Change
Management fee	$	4,154		$	4,720			-12%
Share based compensation		860			629			37%
General and administrative		2,147			1,369			57%
Total	$	7,161		$	6,718			7%
Average equity	$	2,437,624		$	3,066,197			-21%
As a % of average equity, annualized		1.18	%		0.88	%		34%

We attempt to efficiently manage our operating expenses as they directly affect the return on investment.  Our total expenses grew versus 1Q13 as discussed below:

1Q14 vs. 1Q13

· Our management fee is defined as a percentage of our equity per the governing agreement, and decreases as the amount of average equity decreases;

· Our share based compensation increased as we have more employees receiving grants; and

· Our general and administrative costs have increased, including expenses related to additional employees, increased technology (particularly software), insurance and professional fees. These increases are due in part to further enhancement of our risk management capabilities along with the exploration of new asset classes and/or initiatives.

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Reconciliations of Non-GAAP Measures

The reconciliation of core earnings and effective net interest margin to their nearest comparable GAAP measure, net interest margin, is as follows for the three months ended March 31, 2014 and 2013:

	Three Months Ended March 31
	2014			2013
Net interest margin	$	58,138		$	71,406
Less: reclassification of deferred swap losses included in interest expense		24,684			-
Interest rate swaps – monthly net settlements (after hedge de-designation)		(29,412	)		-
Dollar roll income		20,821			-
Effective net interest margin		74,231			71,406
Total operating expenses		(7,161	)		(6,718	)
Dividends on preferred stock		(5,480	)		(5,480	)
Core earnings	$	61,590		$	59,208

The reconciliation of effective interest expense to its nearest comparable GAAP measure, interest expense, along with their respective cost of funds measures, is as follows for the three months ended March 31, 2014 and 2013:

	Three Months Ended March 31
	2014						2013
	Amount			% (1)			Amount		% (1)
Interest expense	$	38,451			0.97	%	$	53,277		0.95	%
Less: reclassification of deferred swap losses included in interest expense (after hedge de-designation)		(24,684	)		-0.63	%		-		0.00	%
Interest rate swaps – monthly net settlements (after hedge de-designation)		29,412			0.75	%		-		0.00	%
Effective interest expense and cost of funds	$	43,179			1.09	%	$	53,277		0.95	%
Average repo and dollar roll liability	$	15,787,282					$	22,342,818
(1) Dollar amount as a percentage of our average repurchase agreements and dollar roll liability

Contractual Obligations and Commitments

We had the following contractual obligations under repurchase agreements as of March 31, 2014:

	March 31, 2014
	Balance		Weighted Average Contractual Rate			Contractual Interest Payments		Total Contractual Obligation
Within 30 days	$	13,752,842		0.28	%	$	2,041	$	13,754,883
30 days to 3 months		1,430,615		0.63	%		1,983		1,432,598
	$	15,183,457		0.33	%	$	4,024	$	15,187,481

From time to time we may make forward commitments to purchase our agency securities.  The commitments require physical settlement with the sellers on settlement date, usually between 30 and 90 days from the date of trade.  The following table shows the ARM agency securities forward purchase commitments as of March 31, 2014.

Face		Cost		Fair Market Value		Due to Brokers
$	70,000	$	71,839	$	72,040	$	71,839

The following table shows the TBA dollar roll securities forward purchase commitments as of March 31, 2014.

Face		Cost		Fair Market Value		Due to Brokers
$	3,400,000	$	3,565,399	$	3,351,765	$	3,159,801

In addition, we had contractual commitments under interest rate swap agreements as of March 31, 2014.  These agreements were for a total notional amount of $10.1 billion, had an average rate of 1.36% and a weighted average term of 22 months.

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Off-Balance Sheet Arrangements

As of March 31, 2014 and December 31, 2013, 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 March 31, 2014 and December 31, 2013, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.

As of March 31, 2014 and December 31, 2013, we had TBA dollar roll transactions outstanding of $3,565,399 and $632,270, respectively.  Forward purchase commitments and TBA dollar roll transactions represent off-balance sheet financing.  Pursuant to ASC 815, we account for these positions as derivative transactions and, consequently, they are not reflected in our on-balance sheet debt and leverage ratios.  

Liquidity and Capital Resources

Our primary sources of funds are borrowings under repurchase arrangements and dollar roll transactions, 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 March 31, 2014, we had uncommitted repurchase facilities with 30 lending counterparties to finance this portfolio, subject to certain conditions, and have borrowings outstanding with 25 of these counterparties.  

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 dollar roll transactions and on derivative instruments when their value declines. This typically occurs when prevailing market rates decrease, with the severity of the decrease also dependent on the term of the derivatives involved.  The amount of any margin call will generally be dollar for dollar, on a daily basis.  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 and often more frequently.  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.  

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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 for the last three years.  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.  

	Average Daily Repurchase Agreements		Repurchase Agreements at Period End		Highest Daily Repurchase Balance During Quarter		Lowest Daily Repurchase Balance During Quarter
March 31, 2014	$	15,685,392	$	15,183,457	$	16,129,683	$	15,085,150
December 31, 2013		17,464,981		16,129,683		18,832,650		16,119,555
September 30, 2013		21,989,907		18,829,771		23,495,767		18,829,771
June 30, 2013		22,701,463		23,077,252		23,429,222		22,383,758
March 31, 2013		22,342,818		22,586,932		23,017,196		21,337,947
December 31, 2012		23,692,240		22,866,429		24,396,444		22,824,383
September 30, 2012		22,541,260		23,583,180		24,299,580		20,152,860
June 30, 2012		19,599,942		20,152,860		21,086,250		16,449,862
March 31, 2012		15,981,764		16,556,630		16,691,652		15,566,983
December 31, 2011		16,280,835		16,162,375		16,807,220		15,886,231
September 30, 2011		14,884,196		15,886,231		15,907,289		14,334,014
June 30, 2011		13,540,291		14,800,594		14,800,594		11,401,240

As of March 31, 2014 and December 31, 2013, 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 4.5% and 4.6%, respectively (weighted by borrowing amount).  This rate has remained fairly constant as lending conditions have been stable.  

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 assets drops beyond a threshold amount, which is usually between $100,000 and $250,000.  This threshold amount is generally set by each counterparty and does not vary based on the notional amount of the repurchase agreements outstanding with that counterparty. Both of these margin calls require a dollar for dollar restoration of the margin shortfall.  The total amount of our unrestricted cash and cash equivalents, plus any unpledged securities, is available to satisfy margin calls, if necessary.  As of March 31, 2014 and December 31, 2013, we had approximately $1.7 billion and $1.6 billion, respectively in agency securities, short term investments, 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.  

One risk to our liquidity is the collateral, or haircut, held by our lenders.  In the event of insolvency by a repurchase agreement lender, our claim to our haircut becomes that of a general unsecured creditor.  For example, in October of 2011, MF Global, Inc., one of our lending counterparties, filed for relief under Chapter 11 of the U.S. Bankruptcy Code.  We were unable to recover approximately $0.8 million that was due us at that time under our repurchase agreement with MF Global, Inc.  Due to the complexity of this estate, it will likely be several years before we receive any clarity as to any recovery, and therefore, we recorded a loss allowance for the total amount due at that time.  

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

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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 few 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.  

Although these conditions have lessened of late, if they increase and 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.  

Liquidity Sources—Dollar Roll Transactions

We may also enter into dollar roll transactions as a source of financing for our investments.  Dollar roll transactions represent a form of financing that may be on or off balance sheet, depending on whether the security rolled is a specified pool or a TBA contract.  TBA contracts that are financed using dollar rolls transactions are accounted for as derivatives and shown on our balance sheet at net fair market value.  Under certain market conditions it may be uneconomical for us to roll our TBA contracts and we may need to settle our obligations and take delivery of the underlying securities.  If we were required to take physical delivery to settle a TBA contract, we would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted.  Our TBA dollar roll transactions are also subject to margin requirements governed by our prime brokerage agreements.  In the event of a margin call, we must generally provide additional collateral on the same business day.  The table below sets forth information regarding the volume of dollar roll transactions (both specified pools and TBA contracts) during the quarters in which we have engaged in dollar roll transaction.

	Average Daily Dollar Roll Liability	Gross Dollar Roll Liability at Period End	Highest Daily Dollar Roll Balance During Quarter	Lowest Daily Dollar Balance During Quarter
March 31, 2014	$         2,935,689	$         3,159,801	$          3,699,859	$          1,037,879
December 31, 2013	$         1,275,595	$         1,037,879	$          2,134,370	$                        -

Liquidity Sources—Capital Offerings

In addition to our repurchase borrowings, we also rely on secondary securities offerings as a source of both short-term and long-term liquidity.  

From time to time, we may sell shares of our common stock in “at the market” offerings.  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.  

On February 29, 2012, we entered into sales agreements (the “2012 Sales Agreements”) with Cantor Fitzgerald & Co. (“Cantor”) and JMP Securities LLC (“JMP”) to establish a new “at-the-market” program (the “2012 Program”).  Under the terms of the 2012 Sales Agreements, we may offer and sell up to 10,000,000 shares of our common stock from time to time through Cantor or JMP, each acting as agent and/or principal.  The shares of our common stock issuable pursuant to the 2012 Program are registered with the SEC on our Registration Statement on Form S-3 (No. 333-179805), which became effective upon filing on February 29, 2012.

No shares of common or preferred stock have been issued since 2012.

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Liquidity Uses—Share Buybacks

On June 18, 2013, our board of directors authorized the Repurchase Program to acquire up to 10,000,000 shares of our common stock.  Over the remainder of 2013, we repurchased 2,485,447 shares of common stock in at-the-market transactions, leaving 7,514,553 shares of repurchase capacity available under the Repurchase Program.  During the three months ended March 31, 2014, we repurchased 100,000 shares at a total cost of $1,912.  We may repurchase additional shares from time to time as liquidity and market conditions permit.

During periods when our board of directors has authorized us to repurchase shares under the Repurchase Program, we will not be authorized to issue shares of common stock under the 2012 Program described above.  Similarly, during periods when our board of directors has authorized us to issue shares of common stock under the 2012 Program, we will not be authorized to repurchase shares under the Repurchase Program.  

Forward-Looking Statements Regarding Liquidity

Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that our 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 six and 12 times the amount of our shareholders’ equity.  Some of our agreements with our derivative counterparties contain restrictive financial covenants, including covenants limiting our leverage levels, the most restrictive of which provide that if we exceed a leverage ratio of 10 to 1, then we could be declared in default on the applicable derivative obligations. At March 31, 2014 and December 31, 2013, our total on-balance sheet borrowings were approximately $15.2 billion and $16.5 billion (excluding accrued interest), respectively, which represented a leverage ratio of approximately 6.3:1 and 7.0:1, respectively.  Our effective leverage ratio (defined as our debt-to-shareholders equity ratio, including the effects of off-balance sheet dollar roll liabilities) was approximately 7.7:1 and 7.3:1 as of March 31, 2014 and December 31, 2013, respectively.  

Inflation

Virtually all of our assets and liabilities are interest rate sensitive in nature.  As a result, interest rates and other factors directly influence our performance far more than inflation.  Although inflation is a primary factor in any interest rate, changes in interest rates do not necessarily correlate with changes in inflation rates, and these affects may be imperfect or lagging.  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.

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Interest Rate Effect on Net Interest Income

Our operating results depend in large part on differences between the yields earned on our investments and our cost of borrowing and hedging activities.  The cost of our borrowings will generally be based on prevailing market interest rates.  During periods of rising interest rates, the borrowing costs associated with agency securities tend to increase while the income earned on agency securities may remain substantially unchanged until the interest rates reset.  This results in a narrowing of the net interest spread between the assets and related borrowings and may even result in losses.  The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase.  Further, an increase in short-term interest rates could also have a negative impact on the market value of our investments.  If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.  

We seek to mitigate interest rate risk through utilization of longer term repurchase agreements and hedging instruments, primarily interest rate swap agreements and Futures Contracts.  These instruments are intended to serve as a hedge against future interest rate increases on our variable rate borrowings.  Hedging techniques are 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 and hybrid 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 margin 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, or move similarly to, 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 our borrowing rate relative to LIBOR or one-year CMT rates may 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.  To date, substantially all of our agency securities have been purchased at a premium.  

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.  

When we receive repayments of principal on our agency securities from prepayments and scheduled payments, to maintain a similar rate of earnings per share, we may want to reinvest the proceeds from these repayments in similar yielding investments.  In

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addition, due to standard settlement conventions, it may take time to reinvest these proceeds and leave a gap in earnings until we can find and settle on suitable investment assets.  In times of market illiquidity or tight supply, we may have periods where similar types of assets are not available to replace those assets repaid to us.  A decrease in earnings could be significant in periods of high prepayments.  

Extension Risk

We invest in agency securities that are either fixed-rate or backed by ARMs which have interest rates that are fixed for the early years of the loan (typically three, five, seven or 10 years) and thereafter reset periodically, on the same basis as agency securities backed by ARMs.  We compute the projected weighted-average life of our agency securities based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgage loans.  In general, when agency securities 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 hedges 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 mortgage loans underlying our agency securities could extend beyond the term of the swap agreement or other hedging instrument.  This is sometimes referred to as “tail risk.”  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 market value interest rate risk by estimating the effective duration of our assets relative to the effective duration 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 annual interest income, at March 31, 2014 and December 31, 2013, assuming a static portfolio.  When evaluating the impact of changes in interest rates on net income, 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.  

March 31, 2014

Change in Interest rates	Percentage Change inProjected Net InterestIncome		Percentage Change inProjected PortfolioValue
+ 1.00%	4.46	%	(0.56	%)
+ 0.50%	3.10	%	(0.25	%)
- 0.50%	0.47	%	0.18	%
- 1.00%	(6.77	%)	0.57	%

December 31, 2013

Change in Interest rates	Percentage Change inProjected Net InterestIncome		Percentage Change inProjected PortfolioValue
+ 1.00%	0.66	%	(0.96	%)
+ 0.50%	1.27	%	(0.47	%)
- 0.50%	6.34	%	0.19	%
- 1.00%	(2.28	%)	0.61	%

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While the charts 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 margin and portfolio value, which includes the value of swaps, should interest rates immediately change.  Given the low level of interest rates at March 31, 2014 and December 31, 2013, 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, 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:

· 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 maintain disclosure controls and procedures to ensure that material information relating to us 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 March 31, 2014, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) are effective to ensure that the information required to be disclosed by us 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 March 31, 2014 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.

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Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on February 21, 2014.

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

Period	Total Number of Shares Purchased(1)	Average Price Paid per Share(2)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(3)
January 1, 2014 – January 31, 2014	-	$            -	-	7,514,553
February 1, 2014 – February 28, 2014	-	$            -	-	7,514,553
March 1, 2014 – March 31, 2014	100,000	$      19.10	100,000	7,414,553
Total	��   100,000	$      19.10	100,000	7,414,553

(1) During the first quarter of 2014, we repurchased 100,000 shares of common stock under the Repurchase Program in at-the-market transactions at a total cost of $1,911,850.

(2) Excludes commissions

(3) On June 18, 2013, our board of directors authorized the Repurchase Program to acquire up to 10,000,000 shares of our common stock.  We may repurchase shares from time to time as liquidity and market conditions permit.  The authorization does not include an expiration date.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

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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
101.INS XBRL	Instance Document (1)
101.SCH XBRL	Taxonomy Extension Schema Document (1)
101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document (1)
101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created (1)
101.LAB XBRL	Taxonomy Extension Label Linkbase Document (1)
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) Consolidated Balance Sheets at March 31, 2014 (Unaudited) and December 31, 2013 (Derived from the audited balance sheet at December 31, 2013); (ii) Consolidated Statements of Income (Unaudited) for the three months ended March 31, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2014 and 2013; (iv) Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) for the three months ended March 31, 2014; (v) Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2014 and 2013; and (vi) Notes to the Consolidated Financial Statements (Unaudited) for the three months ended March 31, 2014.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HATTERAS FINANCIAL CORP.
Dated: April 29, 2014	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
101.INS XBRL	Instance Document (1)
101.SCH XBRL	Taxonomy Extension Schema Document (1)
101.CAL XBRL	Taxonomy Extension Calculation Linkbase Document (1)
101.DEF XBRL	Additional Taxonomy Extension Definition Linkbase Document Created (1)
101.LAB XBRL	Taxonomy Extension Label Linkbase Document (1)
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) Consolidated Balance Sheets at March 31, 2014 (Unaudited) and December 31, 2013 (Derived from the audited balance sheet at December 31, 2013); (ii) Consolidated Statements of Income (Unaudited) for the three months ended March 31, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2014 and 2013; (iv) Consolidated Statement of Changes in Shareholders’ Equity (Unaudited) for the three months ended March 31, 2014; (v) Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2014 and 2013; and (vi) Consolidated Notes to the Financial Statements (Unaudited) for the three months ended March 31, 2014.