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CYS INVESTMENTS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.
In this Quarterly Report on Form 10-Q, we refer to CYS Investments, Inc. as
"we," "us," "our company," or "our," unless we specifically state otherwise or
the context indicates otherwise. The following defines certain of the commonly
used terms in this quarterly report on Form 10-Q: RMBS refers to residential
mortgage-backed securities; agency securities or Agency RMBS refers to our RMBS
that are issued or whose principal and interest payments are guaranteed by a
federally chartered corporation, 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 refers to adjustable-rate
mortgage loans that typically have interest rates that adjust annually to an
increment over a specified interest rate index; and hybrids refers to ARMs that
have interest rates that are fixed for a specified period of time and,
thereafter, generally adjust annually to an increment over a specified interest
rate index.
The following discussion should be read in conjunction with our financial
statements and accompanying notes included in Item 1 of this Quarterly Report on
Form 10-Q as well as our Annual Report on Form 10-K for the fiscal year ended
December 31, 2011, filed on February 13, 2012.
Forward Looking Statements
When used in this Quarterly Report on Form 10-Q, in future filings with the
Securities and Exchange Commission ("SEC") or in press releases or other written
or oral communications, statements which are not historical in nature, including
those containing words such as "believe," "expect," "anticipate," "estimate,"
"plan," "continue," "intend," "should," "may" or similar expressions, are
intended to identify "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, and, as such, may involve known and
unknown risks, uncertainties and assumptions. The forward-looking statements we
make in this Quarterly Report on Form 10-Q include, but are not limited to,
statements about the following:
•            the effect of movements in interest rates on our assets and
             liabilities (including our hedging instruments) and our net income;


•            our investment, financing and hedging strategy and the success of
             these strategies;

• the effect of increased prepayment rates on our portfolio;


•            our ability to convert our assets into cash or extend the financing
             terms related to our assets;


•            the effect of widening credit spreads on the value of our assets and
             investment strategy;

• the types of indebtedness we may incur;

• our ability to quantify risks based on historical experience;


•            our ability to be taxed as a real estate investment trust ("REIT")
             and to maintain an exemption from registration under the Investment
             Company Act of 1940, as amended (the "Investment Company Act");

• our assessment of counterparty risk;


•            our ability to meet short term liquidity requirements with our cash
             flow from operations and borrowings;

• our liquidity;

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• our asset valuation policies;

• our distribution policy; and


•            the effect of recent U.S. Government actions on interest rates and
             the housing and credit markets.


Forward-looking statements are based on our beliefs, assumptions and
expectations of our future performance, taking into account all information
currently available to us. These beliefs, assumptions and expectations are
subject to risks and uncertainties and can change as a result of many possible
events or factors, not all of which are known to us. If a change occurs, our
business, financial condition, liquidity and results of operations may vary
materially from those expressed in our forward-looking statements. The following
factors could cause actual results to vary from our forward-looking statements:
• the factors referenced in this Quarterly Report on Form 10-Q;


• changes in our investment, financing and hedging strategy;


•            the adequacy of our cash flow from operations and borrowings to meet
             our short term liquidity requirements;

• the liquidity of our portfolio;

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•            unanticipated changes in our industry, interest rates, the credit
             markets, the general economy or the real estate market;

• changes in interest rates and the market value of our Agency RMBS;



•            changes in the prepayment rates on the mortgage loans 

underlying our

             Agency RMBS;


• our ability to borrow to finance our assets;

• changes in government regulations affecting our business;


•            our ability to maintain our qualification as a REIT for federal
             income tax purposes;


•            our ability to maintain our exemption from registration

under the

             Investment Company Act and the availability of such exemption in the
             future; and


•            risks associated with investing in real estate assets,

including

             changes in business conditions and the general economy.


These and other risks, uncertainties and factors, including those described
elsewhere in this report, 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 a specialty finance company created with the objective of achieving
consistent risk-adjusted investment income. We seek to achieve this objective by
investing, on a leveraged basis, in Agency RMBS. In addition, our investment
guidelines permit investments in collateralized mortgage obligations issued by a
government agency or government sponsored entity that are collateralized by
Agency RMBS ("CMOs"), although we had not invested in any CMOs as of September
30, 2012. We commenced operations in February 2006, and completed our initial
public offering in June 2009. Our common stock and our Series A Cumulative
Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A
Preferred Stock") trade on the New York Stock Exchange under the symbols "CYS"
and "CYS PrA," respectively.
We earn investment income from our investment portfolio, and we use leverage to
seek to enhance our returns. Our net investment income is generated primarily
from the difference, or net spread, between the interest income we earn on our
investment portfolio and the cost of our borrowings and hedging activities. The
amount of net investment income we earn on our investments depends in part on
our ability to control our financing costs, which comprise a significant portion
of our operating expenses. Although we leverage our portfolio investments in
Agency RMBS to seek to enhance our potential returns, leverage also may
exacerbate losses.
While we use hedging to mitigate some of our interest rate risk, we do not hedge
all of our exposure to changes in interest rates. This is because 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 achieve attractive spreads on our
portfolio.
In addition to investing in issued pools of Agency RMBS, we regularly utilize
forward settling transactions, including forward-settling purchases of Agency
RMBS where the pool is "to-be-announced" ("TBAs"). Pursuant to these TBAs, we
agree to purchase, for future delivery, Agency RMBS with certain principal and
interest terms and certain types of underlying collateral, but the particular
Agency RMBS to be delivered is not identified until shortly before the TBA
settlement date. For our other forward settling transactions, we agree to
purchase, for future delivery, Agency RMBS. However, unlike our TBAs, these
forward settling transactions reference an identified Agency RMBS.
We have elected to be taxed as a REIT and have complied, and intend to continue
to comply, with the provisions of the Internal Revenue Code of 1986, as amended
(the "Internal Revenue Code"), with respect thereto. Accordingly, we generally
do not expect to be subject to federal income tax on our REIT taxable income
that we currently distribute to our stockholders if certain asset, income and
ownership tests and recordkeeping requirements are fulfilled. Even if we
maintain our qualification as a REIT, we may be subject to some federal, state
and local taxes on our income.
Factors that Affect our Results of Operations and Financial Condition
A variety of industry and economic factors may impact our results of operations
and financial condition. These factors include:
• interest rate trends;


•       prepayment rates on mortgages underlying our Agency RMBS, and credit
        trends insofar as they affect prepayment



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rates;

• competition for investments in Agency RMBS;

• actions taken by the U.S. Government, including the U.S. Federal Reserve

(the "Federal Reserve") and the U.S. Treasury;

• credit rating downgrades of the United States' and certain European

countries' sovereign debt; and

• other market developments.

In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. 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 and the requirements to qualify for a registration

exemption under the Investment Company Act.



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 the
corresponding liabilities, such assets will likely change in value more slowly
than the corresponding liabilities. Consequently, changes in interest rates,
particularly short term interest rates, may significantly influence our net
investment income.
Our net investment income may be affected by a difference between actual
prepayment rates and our projections. Prepayments on loans and securities may be
influenced by changes in market interest rates and homeowners' ability and
desire to refinance their mortgages. To the extent we have acquired assets at a
premium or discount to par value, changes in prepayment rates may impact our
anticipated yield.
Trends and Recent Market Impacts
The volatility in the U.S. interest rate markets in 2011 and 2012 has produced
opportunities in our markets. While the performance of the U.S. economy in 2011
was disappointing primarily due to a lack of significant job growth, the first
quarter of 2012 appeared to show some improvement in job growth and U.S. real
gross domestic product ("GDP") growth. However, this trend has not been
sustained and GDP growth expectations have declined in the third quarter of
2012. The Federal Reserve's September 2012 release had their 2012 GDP projection
in the range of 1.6% to 2.0%, which is down from their June projection of 1.6%
to 2.5%. The Federal Reserve's core personal consumption expenditures inflation
projection is low through 2015, at rates ranging from 1.6% to 2.3%.
In September 2012, the U.S. Federal Reserve Open Market Committee announced an
open-ended program to purchase an additional $40 billion of Agency RMBS per
month until the unemployment rate, among other economic indicators, show signs
of improvement. This program, when combined with the Federal Reserve's existing
programs to extend its holdings' average maturity, and reinvest principal
payments from its holdings of agency debt and Agency RMBS into Agency RMBS, is
expected to increase the Federal Reserve's holdings of long-term securities by
approximately $85 billion per month through the end of 2012. The Federal Reserve
also announced that it will keep the target range for the Federal Funds Rate
between zero and 0.25% through at least mid-2015, which is six months longer
than the Federal Reserve had previously announced.
The Federal Reserve expects these measures to put downward pressure on long-term
interest rates. In the short term, these actions have driven Agency RMBS prices
to all-time highs, which has further compressed interest spreads, and removed
the historical correlation between mortgage rates and U.S. Treasury or interest
rate swaps. These factors have contributed to a challenging interest rate
hedging environment.
The U.S. unemployment rate declined in recent months from 8.5% in December 2011
to 7.8% in September 2012. However, this downward trend is partly explained by
the decrease in the participation rate, which went from 64.0% in December 2011
to 63.6% in September 2012. Uncertainty in the marketplace surrounding the
longer-term pace of job creation continues to be a concern for the U.S. economy
and likely will remain a primary focus in the upcoming presidential election.
While existing home sales have increased recently, with some regions showing a
small increase in average home prices, the residential construction sector
remains depressed. According to the U.S. Department of Commerce, privately-owned
housing units authorized by building permits in August 2012 were at a seasonally
adjusted annual rate of 801,000. To put this figure in perspective, the
September 2004 annual rate was 2,041,000.

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In addition, the over hang of the European debt crisis and the recent
downgrading of a significant number of U.S. banks by Moody's also adds pressure
to the U.S. economy and consumer confidence.
Overall inflation and wage pressures have remained relatively muted in recent
months despite prices of crude oil and gasoline increasing in the first nine
months of 2012.
The following trends and recent market impacts may also affect our business:
Interest Rates
As described above, the actions by the Federal Reserve have decoupled U.S.
Treasury rates from mortgage rates. During the nine months ended September 30,
2012, the 10 Year U.S. Treasury rate decreased 24 basis points to 1.64%. This
compares with a decrease of 104 basis points in the yield on par-priced Fannie
Mae Agency RMBS backed by 30 year fixed rate mortgage loans to 1.84% at
September 30, 2012. This demand has come primarily from the Federal Reserve.
Based on Agency RMBS issuance data from Fannie Mae, Freddie Mac and Ginnie Mae
between July and September 2012, it is estimated that the Federal Reserve could
purchase as much as 58% of monthly new issuance through the end of 2012.
During the three months ended September 30, 2012 the average yield on the
Company's purchases of Agency RMBS was 1.86%. The following table illustrates
this market environment by comparing market levels for three benchmark
securities or rates, the yield on five year U.S. Treasury Notes, the three year
interest rate swap rate and the yield of par-priced Fannie Mae Agency RMBS
backed by 15 year fixed rate mortgage loans:
                                                                             Par-priced Fannie
                                 Five Year U.S.       Three Year Interest    Mae 15 year RMBS
Date                              Treasury Note         Rate Swap Rates            Yield
September 30, 2012                       0.625 %                0.439 %                0.820 %
June 30, 2012                            0.718 %                0.624 %                1.706 %
March 31, 2012                           1.039 %                0.758 %                1.997 %
December 31, 2011                        0.832 %                0.820 %                2.102 %
September 30, 2011                       0.952 %                0.736 %                2.124 %
June 30, 2011                            1.761 %                1.147 %                3.143 %
March 31, 2011                           2.277 %                1.571 %                3.494 %
December 31, 2010                        2.006 %                1.279 %                3.401 %


Source: Bloomberg
Short-term rates have remained low, the table below presents 30-Day LIBOR,
3-Month LIBOR and the U.S. Federal Funds Target Rate at the end of each
respective fiscal quarter. The availability of repurchase agreement financing is
stable with interest rates between 0.34% and 0.53% for 30-90 day repurchase
agreements at September 30, 2012. Several of our repurchase agreement
counterparties were downgraded by Moody's in the second quarter of 2012. We
believe that these downgrades resulted in slightly higher financing costs, and
this modestly-incremental cost is likely to remain in place for the foreseeable
future.
Date               30-Day LIBOR     3-Month LIBOR    Federal Funds Target Rate
September 30, 2012      0.214 %          0.359 %                     0.25 %
June 30, 2012           0.246 %          0.461 %                     0.25 %
March 31, 2012          0.241 %          0.468 %                     0.25 %
December 31, 2011       0.295 %          0.581 %                     0.25 %
September 30, 2011      0.239 %          0.374 %                     0.25 %
June 30, 2011           0.186 %          0.246 %                     0.25 %
March 31, 2011          0.243 %          0.303 %                     0.25 %
December 31, 2010       0.261 %          0.303 %                     0.25 %


Source: Bloomberg

In 2012, the yield curve has flattened slightly. This has primarily been the
result of various Federal Reserve actions since September 2011 designed to
maintain the recent low level of the U.S. Federal Funds Target Rate and lower
yields on longer term U.S. Treasury securities, which the Federal Reserve
expects to consequently lower interest rates that are tied to such

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yields, such as mortgage rates and interest rates on commercial loans. Such programs are described in more detail below under the heading "-Government Activity." Below is a graph of the yield curve at September 30, 2012 and December 31, 2011.

                               [[Image Removed]]
Prepayment Rates and Loan Buy-back Programs
Prepayment rates were very low in the summer of 2011 but have increased since
then as mortgages rates continue to push against historical lows. According to
data provided by Freddie Mac, the weighted average commitment rate on a 30 year
fixed rate mortgage was 3.36% in September 2012, compared to 3.95% in December
2011. However, the continued weak U.S. housing market and high unemployment have
reduced many U.S. homeowners' ability to refinance their mortgages. The
following table presents the prepayment rates for the population of Fannie Mae
Agency RMBS backed by 15 year and 30 year fixed rate mortgages:

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11

   Aug-11    Sep-11    Oct-11    Nov-11    Dec-11
15 Year  17.8 %    13.6 %    13.7 %    12.2 %    12.2 %    14.7 %    15.6 %    18.4 %    23.0 %    25.2 %    23.2 %    20.8 %
30 Year  19.5 %    15.5 %    15.4 %    13.4 %    13.0 %    14.9 %    14.9 %    16.8 %    21.4 %    24.4 %    25.2 %    23.6 %


        Jan-12    Feb-12    Mar-12    Apr-12    May-12    Jun-12    Jul-12    Aug-12    Sep-12
15 Year  18.8 %    20.9 %    21.6 %    18.7 %    18.5 %    19.2 %    21.0 %    23.6 %    21.0 %
30 Year  21.6 %    25.0 %    25.8 %    23.7 %    24.8 %    25.8 %    28.0 %    31.2 %    28.0 %



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                               [[Image Removed]]
 Source: eMBS
Government Activity

On October 4, 2012, the Federal Housing Finance Authority (the "FHFA") released
its white paper entitled "Building a New Infrastructure for the Secondary
Mortgage Market" (the "FHFA White Paper"). This release follows up on the FHFA's
February 21, 2012 Strategic Plan for Enterprise Conservatorships, which set
forth three goals for the next phase of the Fannie Mae and Freddie Mac
conservatorships. These three goals are to (i) build a new infrastructure for
the secondary mortgage market, (ii) gradually contract Fannie Mae and Freddie
Mac's presence in the marketplace while simplifying and shrinking their
operations, and (iii) maintain foreclosure prevention activities and credit
availability for new and refinanced mortgages.

The FHFA White Paper proposes a new infrastructure for Fannie Mae and Freddie
Mac that has two basic goals. The first goal is to replace the current, outdated
infrastructures of Fannie Mae and Freddie Mac with a common, more efficient
infrastructure that aligns the standards and practices of the two entities,
beginning with core functions performed by both entities such as issuance,
master servicing, bond administration, collateral management and data
integration. The second goal is to establish an operating framework for Fannie
Mae and Freddie Mac that is consistent with the progress of housing finance
reform and encourages and accommodates the increased participation of private
capital in assuming credit risk associated with the secondary mortgage market.
The FHFA recognizes that there are a number of impediments to their goals which
may or may not be surmountable, such as the absence of any significant secondary
mortgage market mechanisms beyond Fannie Mae, Freddie Mac and Ginnie Mae, and
that their proposals are in the formative stages. As a result, it is unclear if
the proposals will be enacted. If such proposals are enacted, it is unclear how
closely what is enacted will resemble the proposals from the FHFA White Paper or
what the effects of the enactment will be.

In September 2012, the U.S. Federal Reserve Open Market Committee announced an
open-ended program to purchase an additional $40 billion of Agency RMBS per
month until the unemployment rate, among other economic indicators, show signs
of improvement. This program, when combined with the Federal Reserve's existing
programs to extend its holdings' average maturity, and reinvest principal
payments from its holdings of agency debt and Agency RMBS into Agency RMBS, is
expected to increase the Federal Reserve's holdings of long-term securities by
approximately $85 billion per month through the end of 2012. The Federal Reserve
also announced that it will keep the target range for the Federal Funds Rate
between zero and 0.25% through at least mid-2015, which is six months longer
than the Federal Reserve had previously announced.

The Federal Reserve expects these measures to put downward pressure on long-term
interest rates. In the short term, these actions have driven Agency RMBS prices
to new highs, which has further compressed interest spreads, and caused the
historical correlation between mortgage rates and U.S. Treasury or interest rate
swaps to no longer exist.
On January 4, 2012, the Federal Reserve released a report titled "The U.S.
Housing Market: Current Conditions and

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Policy Considerations" to Congress, which provided a framework for thinking
about certain issues and tradeoffs that policy makers might consider. It is
unclear how future legislation may impact the housing finance market and the
investing environment for Agency RMBS as the method of reform is undecided and
has not yet been defined by the regulators.
On September 21, 2011, the Federal Reserve announced its maturity extension
program whereby it intended to sell $400 billion of shorter-term U.S. Treasury
securities by the end of June 2012 and use the proceeds to buy longer-term U.S.
Treasury securities. This program is intended to extend the average maturity of
the securities in the Federal Reserve's portfolio. By reducing the supply of
longer-term U.S. Treasury securities in the market, this action should put
downward pressure on longer-term interest rates, including rates on financial
assets that investors consider to be close substitutes for longer-term U.S.
Treasury securities, like certain types of Agency RMBS. The reduction in
longer-term interest rates, in turn, may contribute to a broad easing in
financial market conditions that the Federal Reserve hopes will provide
additional stimulus to support the economic recovery. In response to lagging
economic growth, in June 2012, the Federal Reserve announced it was adding
another $267 billion and extending the duration of the program aimed at
lengthening the maturity of its portfolio through the end of 2012 in an effort
to put additional downward pressure on long-term interest rates. The Federal
Reserve also reaffirmed its policy to reinvest payments of principal and
interest from its holdings of Agency RMBS.
In September 2011, the White House announced it is working on a major plan to
allow some of the 11 million homeowners who owe more on their mortgages than
their homes are worth to refinance. Consequently, in October 2011 the FHFA
announced changes to the Home Affordable Refinance Program ("HARP") to expand
access to refinancing for qualified individuals and families whose homes have
lost value. One such change is to increase the HARP loan-to-value ceiling above
125%. However, this would only apply to mortgages guaranteed by Fannie Mae,
Freddie Mac or Ginnie Mae. There are many challenging issues to this proposal,
notably the question as to whether a loan with a 125% or greater loan-to-value
ratio qualifies as a mortgage or an unsecured consumer loan. The chances of this
initiative's success and other ideas proposed by the Federal Reserve's white
paper, have created additional uncertainty in the RMBS market, particularly with
respect to possible increases in prepayment rates. According to information
published by the U.S. Department of Housing and Urban Development, 519,500
distressed homeowners were refinanced in the period from January through July of
2012.
In February 2011, the U.S. Department of the Treasury along with the U.S.
Department of Housing and Urban Development released a report titled "Reforming
America's Housing Finance Market" to Congress outlining recommendations for
reforming the U.S. housing system, specifically Fannie Mae and Freddie Mac, and
transforming government involvement in the housing market. It is unclear how
future legislation may impact the housing finance market and the investing
environment for Agency RMBS as the method of reform is undecided and has not yet
been defined by the regulators.
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the "Dodd-Frank Act") into law. The Dodd-Frank Act is
extensive, complicated and comprehensive legislation that impacts practically
all aspects of banking and represents 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 regulatory 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 ("SIFI") by establishing an interagency council on

        systemic risk and implementation of heightened prudential standards and
        regulation by the Board of Governors of the Federal Reserve for SIFI

(including nonbank financial companies), as well as the implementation of

the Federal Deposit Insurance Corporation ("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 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 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



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• reforming regulation of credit rating agencies.



Many of the provisions of the Dodd-Frank Act, including certain provisions
described above are subject to further study, rulemaking, and the discretion of
regulatory bodies. As the hundreds of regulations called for by the Dodd-Frank
Act are promulgated, we will continue to evaluate the impact of any such
regulations. It is unclear how this legislation may impact the borrowing
environment, investing environment for Agency RMBS and interest rate swaps as
much of the bill's implementation has not yet been defined by the regulators.
Certain programs initiated by the U.S. Government, through the Federal Housing
Administration ("FHA") and the FDIC, to provide homeowners with assistance in
avoiding residential mortgage loan foreclosures are currently in effect. The
programs may involve, among other things, the modification of mortgage loans to
reduce the principal amount of the loans or the rate of interest payable on the
loans, or to extend the payment terms of the loans. While the effect of these
programs has not been as extensive as originally expected, the effect of such
programs for holders of Agency RMBS could be that such holders would experience
changes in the anticipated yields of their Agency RMBS due to (i) increased
prepayment rates on their Agency RMBS and (ii) lower interest and principal
payments on their Agency RMBS.
Credit Spreads
Over the past few years, the credit markets generally experienced tightening
credit spreads (specifically, spreads between U.S. Treasury securities and other
securities that are identical in all respects except for ratings) mainly due to
the strong demand for lending opportunities. Generally, when credit spreads
tighten, the value of Agency RMBS increases, which results in an increase in our
book value. Due to these tightening credit spreads our book value has increased.
If credit spreads were to widen, we expect the market value of Agency RMBS would
decrease, which could reduce our book value, but also create an attractive
opportunity to reinvest principal and interest from our existing portfolio as
well as deploy new capital into higher-yielding Agency RMBS.
For a discussion of additional risks relating to our business see "Risk Factors"
beginning on page 45 of this quarterly report on Form 10-Q and in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2011, filed on
February 13, 2012.
Financial Condition
As of September 30, 2012 and December 31, 2011, the Agency RMBS in our portfolio
were purchased at a net premium to their par value due to the average interest
rates on these investments being higher than the prevailing market rates at the
time of purchase. As of September 30, 2012 and December 31, 2011, we had
approximately $923.8 million and $223.5 million, respectively, of unamortized
premium included in the cost basis of our investments.
As of September 30, 2012 and December 31, 2011, our Agency RMBS portfolio
consisted of the following assets:
September 30, 2012
                 Par Value        Fair Value                                Weighted Average
                                                                    Fair
Asset Type             (in thousands)              Cost/Par       Value/Par       MTR(1)          Coupon       CPR(2)
 10 Year Fixed                  $    238,674     $   103.69
          Rate $    224,154                                     $    106.48          N/A            3.50 %       16.0 %
 15 Year Fixed   11,142,835                          104.04          106.38          N/A            3.26 %       16.1 %
          Rate                    11,854,179
 20 Year Fixed      910,489                          104.87          106.25          N/A            3.22 %       11.2 %
          Rate                       967,434

30 Year Fixed 5,293,159 5,685,772 105.83 107.42

          N/A            3.79 %       16.5 %

Rate

Hybrid ARMs 3,652,347 3,850,880 103.07 105.44

         69.3            2.92 %       21.8 %

Total/Weighted

Average $ 21,222,984$ 22,596,939$ 104.35$ 106.47

        69.3   (3)      3.33 %       17.4 %


__________________
December 31, 2011

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                 Par Value      Fair Value                                Weighted Average
                                                                  Fair
Asset Type            (in thousands)             Cost/Par       Value/Par       MTR(1)          Coupon       CPR(2)
 10 Year Fixed
          Rate $   272,115     $   284,948     $   103.96     $    104.72          N/A            3.50 %       13.6 %
 15 Year Fixed
          Rate   4,763,965       5,010,121         102.53          105.17          N/A            3.79 %       17.8 %
 20 Year Fixed
          Rate     551,766         585,103         102.32          106.04          N/A            4.14 %       28.1 %
 30 Year Fixed
          Rate     239,747         259,123         103.09          108.08          N/A            5.00 %       26.3 %
   Hybrid ARMs   3,098,024       3,233,159         102.31          104.36         64.0            3.29 %       20.3 %
Total/Weighted
       Average $ 8,925,617     $ 9,372,454     $   102.50     $    105.01         64.0   (3)      3.66 %       19.5 %


 __________________
(1)    MTR, or "Months to Reset" is the number of months remaining before the
       fixed rate on a hybrid ARM becomes a variable rate. At the end of the
       fixed period, the variable rate will be determined by the margin and the

pre-specified caps of the ARM. After the fixed period, 100% of the hybrid

       ARMS in the portfolio reset annually.


(2)    CPR, or "Constant Prepayment Rate" is a method of expressing the

prepayment rate for a mortgage pool that assumes that a constant fraction

of the remaining principal is prepaid each month or year. Specifically,

the constant prepayment rate is an annualized version of the prior three

month prepayment rate. Securities with no prepayment history are excluded

from this calculation.

(3) Weighted average months to reset of our ARM portfolio.




The CPR of the Company's Agency RMBS portfolio was approximately 15.4% for the
month of October 2012.
Actual maturities of Agency RMBS are generally shorter than stated contractual
maturities (which range up to 30 years), as they are affected by the contractual
lives of the underlying mortgages, periodic payments and prepayments of
principal. As of September 30, 2012 and December 31, 2011, the average final
contractual maturity of the mortgage portfolio is in year 2033 and 2031,
respectively. The average expected life of our Agency RMBS reflects the
estimated average period of time the securities in the portfolio will remain
outstanding. The average expected lives of our Agency RMBS do not exceed five
years, based upon the prepayment model obtained through subscription-based
financial information service providers. The prepayment model considers current
yield, forward yield, the steepness of the yield curve, current mortgage rates,
the mortgage rate of the outstanding loan, loan age, margin and volatility. The
actual lives of the Agency RMBS in our investment portfolio could be longer or
shorter than those estimates depending on the actual prepayment rates
experienced over the lives of the applicable securities.
Hedging Instruments
We seek to hedge as much of the interest rate risk we determine is in the best
interests of our stockholders. Our policies do not contain specific requirements
as to the percentages or amount of interest rate risk we are required to hedge.
No assurance can be given that our hedging activities will have the desired
beneficial impact on our results of operations or financial condition.
Interest rate hedging may fail to protect or could adversely affect us because,
among other things:
•        interest rate hedging can be expensive, particularly during periods of
         rising and volatile interest rates;


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


•        due to prepayments on assets and repayments of debt securing such
         assets, the duration of the hedge may not match the duration of the
         related liability or asset;

• the credit quality of the hedging counterparty may be downgraded to such

an extent that it impairs our ability to sell or assign our side of the

hedging transaction; and

• the hedging counterparty may default on its obligation to pay.



We engage in interest rate swaps and caps as a means of mitigating our interest
rate risk on forecasted interest expense associated with repurchase agreements
for the term of the swap contract. An interest rate swap is a contractual
agreement entered into by two counterparties under which each agrees to make
periodic payments to the other for an agreed period of time based upon a
notional amount of principal. Under the most common form of interest rate swap,
commonly known as a fixed-floating interest rate swap, a series of fixed
interest rate payments on a notional amount of principal is exchanged for a
series of floating interest rate payments on such notional amount. In a simple
interest rate cap, one investor pays a premium for a notional principal amount
based on a capped interest rate (the "cap rate"). When the floating interest
rate (the "floating rate")

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exceeds the cap rate, the investor receives a payment from the cap counterparty
equal to the difference between the floating rate and the cap rate on the same
notional principal amount for a specified period of time. Alternatively, an
investor may receive a premium and pay the difference in cap rate and floating
rate. Below is a summary of our interest rate swaps and caps as of September 30,
2012 and December 31, 2011:
September 30, 2012

Weighted Average

                    Number of Contracts     Notional (000's)         Rate      Maturity    Fair Value (000's)
Interest Rate Swaps                  20     $        6,990,000       1.298 %   June 2015   $         (111,725 )
Interest Rate Caps                   10              3,400,000       1.622 %   July 2019              125,331


December 31, 2011                                                  Weighted Average
                    Number of Contracts     Notional (000's)       Rate      Maturity    Fair Value (000's)
Interest Rate Swaps                  15            4,740,000       1.478 %   July 2014            (79,476 )
Interest Rate Caps                    3              700,000       1.593 %   July 2015              5,966


The current fair value of interest rate swaps and caps is heavily dependent on
the prevailing market fixed rate, the corresponding term structure of floating
rates (known as the yield curve) as well as the expectation of changes in future
floating rates.
Liabilities
We have entered into repurchase agreements to finance some of our purchases of
Agency RMBS. Borrowings under these agreements are secured by our Agency RMBS
and bear interest at rates that have historically moved in close relationship to
LIBOR. At September 30, 2012, we had approximately $13,912.0 million of
liabilities pursuant to repurchase agreements with 25 counterparties that had
weighted average interest rates of approximately 0.42%, and a weighted average
maturity of 29.2 days. In addition, as of September 30, 2012, we had
approximately $6,084.0 million in payable for securities purchased, a portion of
which will be financed through repurchase agreements. At December 31, 2011, we
had approximately $7,880.8 million of liabilities pursuant to repurchase
agreements with 24 counterparties that had weighted average interest rates of
approximately 0.36%, and a weighted average maturity of 27.6 days. In addition,
as of December 31, 2011 we had approximately $463.3 million in payable for
securities purchased, a portion of which was financed through repurchase
agreements. Below is a summary of our payable for securities purchased as of
September 30, 2012 and December 31, 2011 (in thousands).
September 30, 2012
Forward Settling Purchases       Settle Date    Par Value       Payable

FNMA - 20 Year 3.0% Fixed 10/11/2012$ 203,502$ 213,153

FNMA - 15 Year 3.0% Fixed 10/16/2012 150,000 157,750

FNMA - 30 Year 2.21% Hybrid ARM 10/23/2012 52,000 54,927

FNMA - 30 Year 5.0% Fixed 11/14/2012 800,000 873,773

FNMA - 30 Year 3.5% Fixed 11/14/2012 1,900,000 1,989,494

FNMA - 20 Year 3.0% Fixed 11/14/2012 75,000 79,382

FNMA - 15 Year 3.0% Fixed 11/19/2012 275,000 289,717

FNMA - 30 Year 2.29% Hybrid ARM 11/26/2012 100,000 104,057

FNMA - 30 Year 3.5% Fixed 12/12/2012 1,350,000 1,425,328

FNMA - 20 Year 3.0% Fixed 12/12/2012 350,000 368,644

FNMA - 15 Year 3.0% Fixed 12/18/2012 400,000 423,786

FNMA - 30 Year 2.35% Hybrid ARM 12/28/2012 100,000 104,036

$ 5,755,502$ 6,084,047



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December 31, 2011 Forward Settling Purchases Settle Date Par Value Payable FNMA - 15 Year 3.5% Fixed 1/18/2012$ 225,000$ 232,977 FNMA - 30 Year 2.84% Hybrid ARM 1/24/2012 21,000 21,478 FNMA - 30 Year 2.85% Hybrid ARM 1/24/2012 16,000 16,579 FNMA - 30 Year 2.94% Hybrid ARM 1/24/2012 15,000 15,499 FNMA - 30 Year 3.12% Hybrid ARM 1/24/2012 50,000 51,807 FNMA - 30 Year 2.84% Hybrid ARM 1/24/2012 15,000 15,452 FNMA - 30 Year 3.17% Hybrid ARM 1/27/2012 36,000 37,389 FNMA - 30 Year 2.90% Hybrid ARM 2/23/2012 50,000 51,479 FNMA - 30 Year 2.82% Hybrid ARM 3/22/2012 20,000 20,642

$  448,000$ 463,302




Summary Financial Data

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                                       Three Months Ended September 30,         Nine Months Ended September 30,
(In thousands, except per share
numbers)                                    2012                 2011               2012                 2011
INVESTMENT INCOME:
Interest income from Agency RMBS    $          75,609       $     63,548     $        210,108       $    168,263
Other income                                    1,022              1,018                3,639              3,003
Total investment income                        76,631             64,566              213,747            171,266
EXPENSES:
Interest                                       11,893              4,778               27,739             12,352
Operating expenses                              5,340              9,832               15,738             19,116
Total expenses                                 17,233             14,610               43,477             31,468
Net investment income                          59,398             49,956              170,270            139,798
Net gain (loss) from investments              221,127            120,959              322,863            270,003
GAINS AND (LOSSES) FROM SWAP AND
CAP CONTRACTS:
Net swap and cap interest income
(expense)                                     (17,255 )          (15,469 )            (41,448 )          (42,202 )
Net gain (loss) on termination of
swap contracts                                      -                  -                    -             (3,492 )
Net unrealized appreciation
(depreciation) on swap and cap
contracts                                     (21,363 )          (59,125 )            (38,955 )         (116,267 )
Net gain (loss) from swap and cap
contracts                                     (38,618 )          (74,594 )            (80,403 )         (161,961 )
NET INCOME                          $         241,907       $     96,321     $        412,730       $    247,840
DIVIDEND ON PREFERRED STOCK                      (953 )                -                 (953 )                -
NET INCOME AVAILABLE TO COMMON
SHARES                              $         240,954       $     96,321     $        411,777       $    247,840
Net income per common share
(diluted)                           $            1.46       $       1.16     $           3.19       $       3.15
Distributions per common share      $            0.45       $       0.55     $           1.45       $       1.75
Key Metrics*
Average Agency RMBS(1)              $      13,442,454       $  8,350,710     $     11,301,195       $  6,948,539
Average repurchase agreements (2)   $      11,571,371       $  7,474,253     $      9,905,284       $  6,114,159
Average net assets (3)              $       2,300,096       $  1,061,373     $      1,803,466       $    966,675
Average common shares outstanding
(4)                                           165,017             82,641              128,839             78,717
Average yield on Agency RMBS (5)                 2.25 %             3.02 %               2.48 %             3.24 %
Average cost of funds and hedge (6)              1.01 %             1.07 %               0.93 %             1.19 %
Interest rate spread net of hedge
(7)                                              1.24 %             1.95 %               1.55 %             2.05 %
Operating expense ratio (8)                      0.93 %             2.33 %               1.16 %             2.47 %
Leverage ratio (at period end) (9)              7.7:1              7.7:1                7.7:1              7.7:1


__________________

(1)    Our average Agency RMBS for the period was calculated by averaging the
       month end cost basis of our settled Agency RMBS during the period.


(2)    Our average repurchase agreements for the period were calculated by

averaging the month end repurchase agreement balance during the period.


(3)    Our average net assets for the period were calculated by averaging the
       month end net assets during the period.


(4)    Our average common shares outstanding was calculated by averaging the
       daily common shares outstanding during the period.

(5) Our average yield on Agency RMBS for the period was calculated by dividing

       our interest income from Agency RMBS by our average Agency RMBS.


(6)    Our average cost of funds and hedge for the period was calculated by
       dividing our total interest expense, including our net swap and cap
       interest income (expense), by our average repurchase agreements.


(7)    Our interest rate spread net of hedge for the period was calculated by

subtracting our average cost of funds and hedge from our average yield on

Agency RMBS.

(8) Our operating expense ratio is calculated by dividing operating expenses

       by average net assets.


(9)    Our leverage ratio was calculated by dividing (i) our repurchase
       agreements plus payable for securities purchased minus receivable for
       securities sold by (ii) net assets.


*  All percentages are annualized.
Adjusted Interest Rate Spread net of hedge
The Company's interest rate spread net of hedge is low due to the hedging of
investments when purchased rather than when settled which is when they begin
earning interest income. To better reflect the interest rate spread net of hedge
on our

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interest earning assets we adjust it by applying total net swap and cap interest
expense pro rata over average settled Agency RMBS positions relative to average
total Agency RMBS positions. We believe this spread is generally more reflective
of what we expect our interest rate spread net of hedge to be once the forward
purchases settle.
                                       Three Months Ended September 30,         Nine Months Ended September 30,
(In thousands, except per share
numbers)                                    2012                 2011               2012                 2011

Average settled Agency RMBS(1) $ 13,442,454 $ 8,350,710

  $     11,301,195       $  6,948,539
Average total Agency RMBS(2)               18,751,053          9,136,306           14,955,424          8,369,672
Net swap and cap interest income
(expense)                                     (17,255 )          (15,469 )            (41,448 )          (42,202 )
Net swap and cap interest income
(expense) applied to settled Agency
RMBS(3)                                       (12,370 )          (14,139 )            (31,321 )          (35,036 )
Adjusted average cost of funds and
hedge (4)                                        0.84 %             1.00 %               0.79 %             1.04 %
Adjusted interest rate spread net
of hedge (5)                                     1.41 %             2.02 %               1.69 %             2.20 %


____________

(1) Our average settled Agency RMBS for the period is calculated by averaging

the month end cost basis of our settled Agency RMBS during the period.

(2) Our average total Agency RMBS for the period is calculated by averaging

the month end cost basis of our total Agency RMBS during the period.

(3) Our net swap and cap interest income (expense) applied to settled Agency

RMBS is calculated by dividing average settled Agency RMBS by average

       total Agency RMBS multiplied by net swap and cap interest income
       (expense).

(4) Our adjusted average cost of funds and hedge for the period is calculated

by dividing our total interest expense, including our net swap and cap

interest income (expense) applied to settled Agency RMBS, by our average

       repurchase agreements.


(5)    Our adjusted interest rate spread net of hedge for the period is
       calculated by subtracting our adjusted average cost of funds and hedge
       from our average yield on Agency RMBS.



Core Earnings
Core Earnings represents a non-GAAP financial measure and is defined as net
income (loss) available to common shares excluding net gain (loss) from
investments, net gain (loss) on termination of swap contracts and net unrealized
appreciation (depreciation) on swap and cap contracts. In order to evaluate the
effective yield of the portfolio, management uses Core Earnings to reflect the
net investment income of our portfolio as adjusted to reflect the net swap and
cap interest income (expense). Core Earnings allows management to isolate the
interest income (expense) associated with our swaps and caps in order to monitor
and project our borrowing costs and interest rate spread. In addition,
management utilizes Core Earnings as a key metric in conjunction with other
portfolio and market factors to determine the appropriate leverage and hedging
ratios, as well as the overall structure of the portfolio.
We adopted Accounting Standards Codification ("ASC") 946, Clarification of the
Scope of Audit and Accounting Guide Investment Companies ("ASC 946"), prior to
its deferral in February 2008, while most, if not all, other public companies
that invest only in Agency RMBS have not adopted ASC 946. Under ASC 946, we use
the financial reporting specified for investment companies, and accordingly, our
investments are carried at fair value with changes in fair value included in
earnings. Most other public companies that invest only in Agency RMBS include
most changes in the fair value of their investments within shareholders' equity,
not in earnings. As a result, investors are not able to readily compare our
results of operations to those of most of our competitors. We believe that the
presentation of our Core Earnings is useful to investors because it provides a
means to compare our Core Earnings to those of our peers. In addition, because
Core Earnings isolates the net swap and cap interest income (expense), it
provides investors with an additional metric to identify trends in our portfolio
as they relate to the interest rate environment.
The primary limitation associated with Core Earnings as a measure of our
financial performance over any period is that it excludes the effects of net
realized gain (loss) from investments. In addition, our presentation of Core
Earnings may not be comparable to similarly-titled measures of other companies,
which may use different calculations. As a result, Core Earnings should not be
considered as a substitute for our GAAP net income (loss) as a measure of our
financial performance or any measure of our liquidity under GAAP.

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(In thousands)                             Three Months Ended September 30,           Nine Months Ended September 30,
Non-GAAP Reconciliation:                       2012                  2011                2012                 2011

NET INCOME AVAILABLE TO COMMON SHARES $ 240,954 $ 96,321 $ 411,777 $ 247,840 Net (gain) loss from investments

                (221,127 )           (120,959 )          (322,863 )            (270,003 )
Net (gain) loss on termination of swap
contracts                                              -                    -                   -                 3,492
Net unrealized (appreciation)
depreciation on swap and cap contracts            21,363               59,125              38,955               116,267
Core Earnings                           $         41,190       $       34,487     $       127,869       $        97,596


Results of Operations
Three Months Ended September 30, 2012 Compared to the Three Months Ended
September 30, 2011
Net Income. Net income increased $145.6 million to $241.9 million for the three
months ended September 30, 2012, compared to net income of $96.3 million for the
three months ended September 30, 2011. The major components of this increase are
detailed below.
Investment Income. Investment income, which primarily consists of interest
income on Agency RMBS, increased by $12.0 million to $76.6 million for the three
months ended September 30, 2012, as compared to $64.6 million for the three
months ended September 30, 2011. The change in investment income was primarily
due to the increased size of our portfolio. During the three months ended
September 30, 2012, our average Agency RMBS portfolio was $13,442.5 million,
compared to $8,350.7 million during the three months ended September 30, 2011.
However, the increased income due to the size of our portfolio was partially
offset by the decrease in the average yield on Agency RMBS. During the three
months ended September 30, 2012 and 2011, our average yield on Agency RMBS was
2.25% and 3.02%, respectively.
Interest Expense. Interest expense increased $7.1 million to $11.9 million for
the three months ended September 30, 2012, as compared to $4.8 million for the
three months ended September 30, 2011. The increase was due to the increase in
our average amounts outstanding under our repurchase agreements and higher
interest rates. During the three months ended September 30, 2012 and 2011, our
average repurchase agreements were $11,571.4 million and $7,474.3 million,
respectively. In addition, we had an average rate on our repurchase agreements
of 0.41% and 0.26% during the three months ended September 30, 2012 and 2011,
respectively.
Operating Expenses. For the three months ended September 30, 2012, operating
expenses decreased by $4.5 million to $5.3 million compared to $9.8 million for
the three months ended September 30, 2011. Expenses also decreased as a
percentage of net assets during the three months ended September 30, 2012 to
0.93% compared to 2.33% during the three months ended September 30, 2011. The
primary reason for the decrease in our operating expenses was the non-recurring
expenses of $4.9 million, associated with the Internalization during the three
months ended September 30, 2011. The decrease in expenses as a percentage of net
assets was mainly attributable to our larger asset base. Our average net assets
were $2,300.1 million and $1,061.4 million during the three months ended
September 30, 2012 and 2011, respectively. In addition, we are experiencing the
benefit of the Internalization of management which took effect in September
2011.
Net Gain (Loss) From Investments. Net gain from investments increased by $100.1
million to $221.1 million for the three months ended September 30, 2012,
compared to $121.0 million for the three months ended September 30, 2011. In
both the three months ended September 30, 2012 and 2011, prices of Agency RMBS
rose. However, during the three months ended September 30, 2012, the size of our
Agency RMBS book was significantly larger at an average of $13,442.5 million
compared to $8,350.7 million during the three months ended September 30, 2011.
During the three months ended September 30, 2012 we sold CLOs with a par value
of $14.4 million for a net gain of $2.6 million compared to $2.0 million par
value for a net gain of $0.7 million for the three months ended September 30,
2011.
Net Gain (Loss) from Swap and Cap Contracts. Net loss from swap and cap
contracts decreased by $36.0 million to a loss of $38.6 million for the three
months ended September 30, 2012, compared to a loss of $74.6 million for the
three months ended September 30, 2011. The decrease in net loss on swap and cap
contracts was primarily due to the change in swap rates combined with the change
in the size of our interest rate swap and cap portfolio. During the three months
ended September 30, 2012 and 2011, our average interest rate swap and cap
notional amount was $9,077.5 million and $5,440.0 million, respectively. During
the three months ended September 30, 2012 and 2011, three year swap rates
decreased by 19 and 41 basis points, respectively.
Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September
30, 2011
Net Income. Net income increased $164.9 million to $412.7 million for the nine
months ended September 30, 2012, compared to net income of $247.8 million for
the nine months ended September 30, 2011. The major components of this

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increase are detailed below.
Investment Income. Investment income, which primarily consists of interest
income on Agency RMBS, increased by $42.4 million to $213.7 million for the nine
months ended September 30, 2012, as compared to $171.3 million for the nine
months ended September 30, 2011. The change in investment income was primarily
due to the increased size of our portfolio. During the nine months ended
September 30, 2012, our average Agency RMBS portfolio was $11,301.2 million,
compared to $6,948.5 million during the nine months ended September 30, 2011.
However, the increased income due to the size of our portfolio was partially
offset by the decrease in the average yield on Agency RMBS. During the nine
months ended September 30, 2012 and 2011, our average yield on Agency RMBS was
2.48% and 3.24%, respectively.
Interest Expense. Interest expense increased $15.3 million to $27.7 million for
the nine months ended September 30, 2012, as compared to $12.4 million for the
nine months ended September 30, 2011. The increase was due to the increase in
our average amounts outstanding under our repurchase agreements and higher
rates. During the nine months ended September 30, 2012 and 2011, our average
repurchase agreements were $9,905.3 million and $6,114.2 million, respectively.
In addition, we had an average rate on our repurchase agreements of 0.37% and
0.27% during the nine months ended September 30, 2012 and 2011, respectively.
Operating Expenses. For the nine months ended September 30, 2012, operating
expenses decreased by $3.4 million to $15.7 million compared to $19.1 million
for the nine months ended September 30, 2011. Expenses as a percentage of net
assets also decreased during the nine months ended September 30, 2012 to 1.16%
compared to 2.47% during the nine months ended September 30, 2011. The primary
reason for the decrease in expenses as a percentage of net assets was that we
had a larger asset base. Our average net assets were $1,803.5 million and $966.7
million during the nine months ended September 30, 2012 and 2011, respectively.
In addition, we are experiencing the benefit of the Internalization of
management which took effect in September 2011.
Net Gain (Loss) From Investments. Net gain from investments increased by $52.9
million to $322.9 million for the nine months ended September 30, 2012, compared
to $270.0 million for the nine months ended September 30, 2011. In both the nine
months ended September 30, 2012 and September 30, 2011, prices of Agency RMBS
rose. However, during the nine months ended September 30, 2012, the size of our
Agency RMBS book was significantly larger at an average of $11,301.2 million and
compared to $6,948.5 million during the months ended September 30, 2011.
During the nine months ended September 30, 2012 we sold CLOs with a par value of
$14.4 million for a net gain of $2.6 million compared to $2.0 million par value
for a net gain of $0.7 million for the nine months ended September 30, 2011.
Net Gain (Loss) from Swap and Cap Contracts. Net loss from swap and cap
contracts decreased by $81.6 million to a loss of $80.4 million for the nine
months ended September 30, 2012, compared to a loss of $162.0 million for the
nine months ended September 30, 2011. The decrease in net loss on swap contracts
was primarily due to the change in swap rates combined with the change in the
size of our interest rate swap and cap portfolio. During the nine months ended
September 30, 2012 and 2011, our average interest rate swap and cap notional
amount was $7,055.0 million and $5,115.0 million, respectively. During the nine
months ended September 30, 2012 and 2011, three year swap rates decreased by 38
and 54 basis points, respectively.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations for repurchase
agreements, interest expense on repurchase agreements and the office lease at
September 30, 2012 and December 31, 2011 (dollars in thousands).
                                       Within One      One to Three         Three to
September 30, 2012                        Year             Years           Five Years          Total
Repurchase agreements                $ 13,911,977     $           -     $            -     $ 13,911,977
Interest expense on repurchase
agreements, based on rates at
September 30, 2012                          9,904                 -                  -            9,904
Long term operating lease obligation          319               243                  -              562
Total                                $ 13,922,200     $         243     $            -     $ 13,922,443


                                      Within One      One to three         Three to
December 31, 2011                        Year             Years           Five Years          Total
Repurchase agreements                $ 7,880,814     $           -     $            -     $ 7,880,814
Interest expense on repurchase
agreements, based on rates at
December 31, 2011                          5,852                 -                  -           5,852
Long term operating lease obligation         313               482                  -             795
Total                                $ 7,886,979     $         482     $            -     $ 7,887,461



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We enter into interest rate swap and cap contracts as a means of mitigating our
interest rate risk on forecasted interest expense associated with repurchase
agreements for the term of the swap or cap contract. At September 30, 2012 and
December 31, 2011, we had interest rate swap and cap contracts with the
following counterparties (dollars in thousands):
As of September 30, 2012
                                                                                         Weighted
                                                                                          Average
                                           Total            Fair           Amount        Maturity
Counterparty                              Notional         Value        At Risk  (1)     in Years
BNP Paribas                            $    250,000     $     (124 )   $      1,095           4.9
Credit Suisse International               2,050,000         27,208           13,198           6.2
Deutsche Bank                             1,340,000        (12,745 )         15,161           2.8
Goldman Sachs                             1,800,000        (39,288 )         21,619           1.7
ING Capital Markets, LLC                    300,000          9,057             (443 )         6.7
Morgan Stanley Capital Markets              750,000         28,649            9,309           7.9

Nomura Global Financial Products, Inc. 550,000 (21,608 )

   4,993           2.8
The Bank of Nova Scotia                     250,000            (64 )            566           4.9
The Royal Bank of Scotland plc            2,500,000          5,134            6,033           2.7
UBS AG                                      300,000          9,389              269           6.8
Wells Fargo Bank, N.A.                      300,000          7,998              (51 )         6.7
Total                                  $ 10,390,000     $   13,606     $     71,749


As of December 31, 2011
                                                                                    Weighted
                                                                                     Average
                                          Total          Fair          Amount       Maturity
Counterparty                             Notional        Value       At Risk(1)     in Years
Deutsche Bank                          $   840,000    $ (10,275 )   $     11,846         2.4
Goldman Sachs                            1,800,000      (36,205 )         18,025         2.5
Morgan Stanley Capital Markets             250,000         (723 )          1,236         5.0
Nomura Global Financial Products, Inc.     550,000      (17,176 )          4,679         3.6
The Royal Bank of Scotland plc           2,000,000       (9,131 )          6,965         2.4
Total                                  $ 5,440,000    $ (73,510 )   $     42,751


 __________________

(1) Equal to the fair value of pledged securities plus accrued interest

income, minus the fair value of the interest rate swap and cap and accrued

interest income and expense.



We enter into certain contracts that contain a variety of indemnification
obligations, principally with our brokers and counterparties to interest rate
swap contracts and repurchase agreements. The maximum potential future payment
amount we could be required to pay under these indemnification obligations is
unlimited. We have not incurred any costs to defend lawsuits or settle claims
related to these indemnification obligations. As a result, the estimated fair
value of these agreements is minimal. Accordingly, we recorded no liabilities
for these agreements as of September 30, 2012 and December 31, 2011. In
addition, as of September 30, 2012 and December 31, 2011, we had a $6,084.0
million and $463.3 million payable for securities purchased, respectively, a
portion of which either was or will be financed through repurchase agreements. A
summary of our payable for securities purchased as of September 30, 2012 and
December 31, 2011 is included in the "Financial Condition-Liabilities" section.
Off-Balance Sheet Arrangements
As of September 30, 2012 and December 31, 2011, we did not maintain any
relationships with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance, 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
September 30, 2012 and December 31, 2011, we had not guaranteed any obligations
of unconsolidated entities or entered into any commitment or had any intent to
provide funding to any such entities.
Liquidity and Capital Resources
Our primary sources of funds are borrowings under repurchase arrangements and
monthly principal repayments and

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interest payments on our investments. Other sources of funds may include
proceeds from debt and equity offerings and asset sales. As of September 30,
2012 and December 31, 2011, we had repurchase agreements totaling $13,912.0
million and $7,880.8 million, respectively, with a weighted average borrowing
rate of 0.42% and 0.36%, respectively. In addition, during the nine months ended
September 30, 2012 and 2011, we received $1,940.3 million and $829.0 million of
principal repayments and $191.1 million and $159.9 million of interest payments,
respectively. We held cash and cash equivalents of $20.5 million and $11.5
million at September 30, 2012 and December 31, 2011, respectively.
During the nine months ended September 30, 2012 and 2011, our operations used
net cash of $7,214.3 million and $4,268.0 million, respectively. During the nine
months ended September 30, 2012 and 2011, we had net purchases of securities
(net of purchases, sales and principal repayments) of $12,926.4 million and
$2,919.4 million, respectively. The increase in net purchases of securities was
the result of investing the total net proceeds from the (i) February 1, 2012 and
July 16, 2012 public offerings of common stock which raised approximately $377.3
million and $622.2 million of net proceeds, respectively, (ii) the August 3,
2012 public offering of Series A Preferred Stock which raised approximately
$72.5 million of net proceeds and (iii) the issuance and sale of shares under
the dividend reinvestment and direct stock purchase plan ("DSPP") and Equity
Placement Program ("EPP"), while maintaining our leverage ratio.
Through the DSPP, stockholders may purchase additional shares of common stock by
reinvesting some or all of the cash dividends received on shares of common
stock. Stockholders may also make optional cash purchases of shares of common
stock subject to certain limitations detailed in the plan prospectus. For the
nine months ended September 30, 2012 and 2011 we issued 5,327,661 and 9,192
shares under the plan, respectively, raising approximately $74.0 million and
$0.1 million of net proceeds, respectively. As of September 30, 2012 and
December 31, 2011, there were approximately 4.1 million and 9.4 million shares,
respectively available for issuance under the DSPP.
On June 7, 2011 we established the EPP whereby, from time to time, we may
publicly offer and sell up to 15.0 million shares of our common stock in
at-the-market transactions and/or privately negotiated transactions with JMP
Securities LLC acting as sales agent. For the nine months ended September 30,
2012 the Company issued 11,918,553 shares under the plan raising approximately
$164.3 million. The Company did not issue any shares under the plan during the
nine months ended September 30, 2011. As of September 30, 2012 and December 31,
2011, there were approximately 3.1 million and 15.0 million shares of common
stock, respectively, remained available for issuance to be sold under the EPP.
The following tables present certain information regarding our risk exposure on
our repurchase agreements as of September 30, 2012 and December 31, 2011
(dollars in thousands):


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September 30, 2012
                                                                                            Weighted
                                         Total                                               Average
                                      Outstanding         % of         % of Net Assets     Maturity in
Counterparty                           Borrowings         Total          At Risk (1)          Days
Bank of America Securities LLC       $  1,153,279             8.3    %       2.5 %                 47
Bank of Nova Scotia                       651,503             4.7            0.8                   43
Barclays Capital, Inc.                  1,145,405             8.2            2.3                   53
BNP Paribas Securities Corp               660,121             4.7            1.4                   16
Cantor Fitzgerald & Co.                   210,581             1.5            0.5                   11
Citigroup Global Markets, Inc.            475,957             3.4            1.0                   21
Credit Suisse Securities (USA) LLC        647,308             4.7            1.1                   18
Daiwa Securities America, Inc.            293,674             2.1            0.6                   42
Deutsche Bank Securities Inc.             537,262             3.9            1.2                   21
Goldman Sachs & Co.                       788,524             5.7            1.6                   18
Guggenheim Liquidity Services, LLC        245,567             1.8            0.5                   21
Industrial and Commercial Bank of
China Financial Services LLC              825,251             5.9            1.6                   18
ING Financial Markets LLC                 394,666             2.8            0.9                   14
Jefferies & Company, Inc.                  82,559             0.6            0.2                   17
KGS Alpha Capital Markets                  94,653             0.7            0.2                   23
LBBW Securities LLC                       188,240             1.4            0.4                   51
Mitsubishi UFJ Securities (USA),
Inc.                                      498,179             3.6            1.0                   45
Mizuho Securities USA, Inc.               556,893             4.0            1.3                   13
Morgan Stanley & Co. Inc.                 659,175             4.7            1.4                   30
Nomura Securities International,
Inc.                                      628,791             4.5            1.5                   21
RBC Capital Markets, LLC                  698,620             5.0            1.5                   18
South Street Securities LLC               377,416             2.7            1.1                   18
The Royal Bank of Scotland PLC            158,729             1.1            0.3                   10
UBS Securities LLC                        942,641             6.8            2.1                   54
Wells Fargo Securities, LLC               996,983             7.2            1.4                   18
                                     $ 13,911,977           100.0    %      28.4 %




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December 31, 2011
                                                                                           Weighted
                                            Total                                           Average
                                         Outstanding        % of      % of Net Assets     Maturity in
Counterparty                              Borrowings       Total        At Risk (1)          Days
Bank of America Securities LLC          $    242,641          3.1 %         1.3 %                 19
Bank of Nova Scotia                          416,381          5.3           1.3                   33
Barclays Capital, Inc.                       414,103          5.3           2.1                   52
BNP Paribas Securities Corp                  282,544          3.6           1.4                   13
Cantor Fitzgerald & Co.                      411,499          5.2           2.1                   36
Citigroup Global Markets, Inc.               244,284          3.1           1.3                   20
Credit Suisse Securities (USA) LLC           414,021          5.2           1.9                   47
Daiwa Securities America, Inc.               288,960          3.6           1.5                   30
Deutsche Bank Securities, Inc.               557,902          7.1           3.0                   11
Goldman Sachs & Co.                          543,768          6.9           2.8                   22
Guggenheim Liquidity Services, LLC           151,530          1.9           0.8                   23
Industrial and Commercial Bank of
China Financial Services LLC                 415,863          5.3           2.3                   30
ING Financial Markets LLC                    419,837          5.3           2.2                   19
Jefferies & Company, Inc.                    101,235          1.3           0.5                   17
LBBW Securities LLC                          206,734          2.6           1.0                   45
Mitsubishi UFJ Securities (USA), Inc.        482,404          6.1           2.4                   35
Mizuho Securities USA, Inc.                  297,917          3.8           1.5                   20
Morgan Stanley & Co. Inc.                    172,063          2.2           1.0                   45
Nomura Securities International, Inc.        281,998          3.6           1.4                   41
RBC Capital Markets, LLC                     223,831          2.8           1.3                   12
South Street Securities LLC                  336,394          4.3           2.1                   18
The Royal Bank of Scotland PLC               143,628          1.8           0.7                   10
UBS Securities LLC                           328,368          4.2           1.7                   47
Wells Fargo Securities, LLC                  502,909          6.4           1.7                   10
Total                                   $  7,880,814        100.0 %        39.3 %



____________________

(1) Equal to the fair value of pledged securities plus accrued interest

income, minus the sum of repurchase agreement liabilities and accrued

interest expense divided by net assets.



Our repurchase agreements contain typical provisions and covenants as set forth
in the standard master repurchase agreement published by the Securities Industry
and Financial Markets Association. Our repurchase agreements generally require
us to transfer additional securities to the counterparty in the event the value
of the securities then held by the counterparty in the margin account falls
below specified levels and contain events of default in cases where we or the
counterparty breaches our respective obligations under the agreement.
We receive margin calls from our repurchase agreement counterparties from time
to time in the ordinary course of business similar to other entities in the
specialty finance business. We receive two types of margin calls under our
repurchase agreements. The first type, which are known as "factor calls," are
margin calls that occur each month and relate to the timing difference between
the reduction of principal balances of our Agency RMBS, due to monthly principal
payments on the underlying mortgages, and the receipt of the corresponding cash.
The second type of margin call we may receive is a "valuation call", which
occurs due to market and interest rate movements. Both factor and valuation
margin calls occur if the total value of our assets pledged as collateral to a
counterparty drops beyond a threshold level, typically between $100,000 and
$500,000. Both types of margin calls require a dollar for dollar restoration of
the margin shortfall. Conversely, we may initiate margin calls to our
counterparties when the value of our assets pledged as collateral with a
counterparty increases above the threshold level, thereby increasing our
liquidity. All unrestricted cash and cash equivalents, plus any unpledged
securities, are available to satisfy margin calls

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As of September 30, 2012 and December 31, 2011, we had approximately $1,769.2
million and $580.0 million, respectively, in Agency RMBS, U.S. Treasury
securities and cash and cash equivalents available to satisfy future margin
calls. To date, we have maintained sufficient liquidity to meet margin calls,
and we have never been unable to satisfy a margin call, although no assurance
can be given that we will be able to satisfy requests from our lenders to post
additional collateral in the future.
An event of default or termination event under the standard master repurchase
agreement would give our counterparty the option to terminate all repurchase
transactions existing with us and make any amount due by us to the counterparty
to be payable immediately.
We have made and intend to continue to make regular quarterly distributions of
all or substantially all of our REIT taxable income to holders of our common
stock. In order to qualify as a REIT and to avoid federal corporate income tax
on the income that we distribute to our stockholders, we are required to
distribute at least 90% of our REIT taxable income, determined without regard to
the deduction for dividends paid and excluding net capital gain, on an annual
basis. This requirement can impact our liquidity and capital resources.
For our short term (one year or less) and long term liquidity and capital
resource requirements, we also rely on the cash flow from operations, primarily
monthly principal and interest payments to be received on our Agency RMBS, as
well as any securities offerings authorized by our board of directors.
Based on our current portfolio, leverage rate and available borrowing
arrangements, we believe that our cash flow from operations and the utilization
of borrowings will be sufficient to enable us to meet anticipated short term
(one year or less) liquidity requirements such as funding our investment
activities, funding our distributions to stockholders and for general corporate
expenses. However, an increase in prepayment rates substantially above our
expectations could cause a temporary liquidity shortfall due to the timing of
the necessary margin calls on the financing arrangements and the actual receipt
of the cash related to principal paydowns. If our cash resources are at any time
insufficient to satisfy our liquidity requirements, we may have to issue debt or
additional equity securities or sell Agency RMBS in our portfolio. If required,
the sale of Agency RMBS at prices lower than their amortized cost would result
in realized losses. We believe that we have additional capacity through
repurchase agreements to leverage our equity further should the need for
additional short term (one year or less) liquidity arise.
We may increase our capital resources by obtaining long term credit facilities
or making public or private offerings of equity or debt securities. 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.
Qualitative and Quantitative Disclosures about Short Term Borrowings
The following table discloses quantitative data about our short term borrowings
under repurchase agreements during the three and nine months ended September 30,
2012 and 2011.
                                           Three Months Ended September 30,          Nine Months Ended September 30,
(In millions)                                  2012                 2011                 2012                2011
Outstanding at period end               $        13,912       $       7,541       $        13,912       $       7,541
Weighted average rate at period end                0.42 %              0.28 %                0.42 %              0.28 %

Average outstanding during period (1) $ 11,571 $ 7,474

       $         9,905       $       6,114
Weighted average rate during period                0.41 %              0.26 %                0.37 %              0.27 %

Largest month end balance during period $ 13,912 $ 7,548

      $        13,912       $       7,548



_______________

(1) Calculated based on the average month end balance during the period.



During the three months ended September 30, 2012, our repurchase agreement
balance increased due to our July 16, 2012 public offering of our common stock
and our August 3, 2012 offering of our Series A Preferred Stock, which allowed
us to finance additional asset purchases. During the three months ended
September 30, 2011, our repurchase agreement balance remained stable. The rate
on repurchase agreements was relatively unchanged during the three months ended
September 30, 2012 and 2011. During the nine months ended September 30, 2012 our
repurchase agreement balance increased due to our February 1, 2012 and July 16,
2012 public offerings and our August 3, 2012 offering of our Series A Preferred
Stock, which allowed us to finance additional asset purchases. During the three
and nine months ended September 30, 2011, our repurchase agreement balance
increased during the end of the period due to forward settling purchases made
with the net proceeds from our February 2011 equity offering settling and being
financed through repurchase agreements. During the nine months ended

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September 30, 2011, the weighted average rate on our repurchase agreements
remained relatively stable. However, during the nine months ended September 30,
2012, the rate was higher by five basis points at the end of the period compared
to the average. This increase is partly explained by the European debt crisis
and the downgrading of a significant number of U.S. banks by Moody's during the
nine months ended September 30, 2012.

Inflation

Virtually all of our assets and liabilities are interest rate sensitive in
nature. As a result, interest rates and other factors influence our performance
far more than inflation. Changes in interest rates do not necessarily correlate
with inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our distributions are determined by our
board of directors based in part on our REIT taxable income as calculated
according to the requirements of the Internal Revenue 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
As of September 30, 2012 and December 31, 2011, the primary component of our
market risk was interest rate risk, as described below. While we do not seek to
avoid risk completely, we do believe that risk can be quantified from historical
experience and seek to actively manage risk, to earn sufficient compensation to
justify taking risks and to maintain capital levels consistent with the risks we
undertake. Our board of directors exercises oversight of risk management in many
ways, including overseeing our senior management's risk-related responsibilities
and reviewing management and investment policies and performance against these
policies and related benchmarks. See "Business-Risk Management" in our annual
report on Form 10-K for the fiscal year ended December 31, 2011 for a further
discussion of our risk mitigation practices.
Interest Rate Risk
We are subject to interest rate risk in connection with our investments in
Agency RMBS collateralized by ARMs, hybrid ARMs and fixed rate mortgage loans
and our related debt obligations, which are generally repurchase agreements of
limited duration that are periodically refinanced at current market rates. We
seek to mitigate this risk through utilization of derivative contracts,
primarily interest rate swap and cap agreements.
Effect on Net Investment Income. We fund our investments in long term Agency
RMBS collateralized by ARMs, hybrid ARMs and fixed rate mortgage loans with
short term borrowings under repurchase agreements. During periods of rising
interest rates, the borrowing costs associated with those Agency RMBS tend to
increase while the income earned on such Agency RMBS (during the fixed rate
component of such securities) may remain substantially unchanged. This results
in a narrowing of the net interest spread between the related assets and
borrowings and may even result in losses.
We are a party to the interest rate swap and contracts as of September 30, 2012
and December 31, 2011 described in detail under Item 2. "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Contractual
Obligations and Commitments" in this quarterly report on Form 10-Q.
Hedging techniques are partly based on assumed levels of prepayments of our
Agency RMBS. If prepayments are slower or faster than assumed, the life of the
Agency RMBS will be longer or shorter, which would reduce the effectiveness of
any hedging strategies we may use and may cause losses on such transactions.
Effect on Fair Value. Another component of interest rate risk is the effect
changes in interest rates will have on the fair value of our assets. We face the
risk that the fair value of our assets will increase or decrease at different
rates than that of our liabilities, including our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our
assets and the duration of our liabilities. Duration essentially measures the
market price volatility of financial instruments as interest rates change. We
generally calculate duration using various third-party financial models and
empirical data. Different models and methodologies can produce different
duration numbers for the same securities.
Extension Risk. We invest in Agency RMBS collateralized by hybrid ARMs, which
have interest rates that are fixed for the first few years of the loan
(typically three, five, seven or 10 years) and thereafter reset periodically on
the same basis as Agency RMBS collateralized by ARMs. We compute the projected
weighted average life of our Agency RMBS collateralized by hybrid ARMs based on
assumptions regarding the rate at which the borrowers will prepay the underlying
mortgages. In general, when Agency RMBS collateralized by fixed rate or hybrid
ARMs is 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 RMBS. 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 collateral underlying the related
Agency RMBS.

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We have structured our swaps to expire in conjunction with the estimated
weighted average life of the fixed period of the mortgages underlying our Agency
RMBS portfolio. However, in a rising interest rate environment, the weighted
average life of the fixed rate mortgages underlying our Agency RMBS could extend
beyond the term of the swap agreement or other hedging instrument. This could
have a negative impact on our results from operations, as borrowing costs would
no longer be fixed after the term of the hedging instrument while the income
earned on the remaining Agency RMBS would remain fixed for a period of time.
This situation may also cause the market value of our Agency RMBS 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 Cap Risk. Both the ARMs and hybrid ARMs that collateralize our
Agency RMBS are typically subject to periodic and lifetime interest rate caps
and floors, which limit the amount by which the security's interest yield may
change during any given period. However, our borrowing costs will not be subject
to similar restrictions. Therefore, in a period of increasing interest rates,
the interest costs on our borrowings could increase without limitation by caps
while the interest rate yields on our Agency RMBS would effectively be limited
by caps. This problem will be magnified to the extent that we acquire Agency
RMBS that are collateralized by hybrid ARMs that are not fully indexed. In
addition, the underlying mortgages 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 income on our Agency
RMBS than we need in order to pay the interest cost on our related borrowings.
These factors could lower our net investment income or cause a net loss during
periods of rising interest rates, which would harm our financial condition, cash
flows and results of operations.
Interest Rate Mismatch Risk. We intend to fund a substantial portion of our
acquisitions of Agency RMBS with borrowings that, after the effect of hedging,
have interest rates based on indices and repricing terms similar to, but of
somewhat shorter maturities than, the interest rate indices and repricing terms
of the Agency RMBS. Thus, we anticipate that in most cases the interest rate
indices and repricing terms of our Agency RMBS and our funding sources will not
be identical, thereby creating an interest rate mismatch between assets and
liabilities. Therefore, our cost of funds would likely rise or fall more quickly
than would our earnings rate on assets. During periods of changing interest
rates, such interest rate mismatches could negatively impact our financial
condition, cash flows and results of operations. To mitigate interest rate
mismatches, we may utilize the hedging strategies discussed above.
Our analysis of risks is based on management's experience, estimates, models and
assumptions. These analyses rely on models which utilize estimates of fair value
and interest rate sensitivity. Actual economic conditions or implementation of
investment decisions by our management may produce results that differ
significantly from the estimates and assumptions used in our models and the
projected results reflected herein.
Prepayment Risk
Prepayments are the full or partial repayment of principal prior to the original
contractual maturity of a mortgage loan and typically occur due to refinancing
of mortgage loans. Prepayment rates for existing Agency RMBS generally increase
when prevailing mortgage interest rates fall. In addition, prepayment rates on
Agency RMBS collateralized by ARMs and hybrid ARMs generally increase when the
difference between long term and short term interest rates declines or becomes
negative. Additionally, we currently own Agency RMBS that were purchased at a
premium. The prepayment of such Agency RMBS at a rate faster than anticipated
would result in a write-off of any remaining capitalized premium amount.
We seek to mitigate our prepayment risk by investing in Agency RMBS with (i) a
variety of prepayment characteristics, (ii) prepayment prohibitions and
penalties and (iii) prepayment protections, as well as by balancing Agency RMBS
purchased at a premium with Agency RMBS purchased at a discount.
Effect on Fair Value and Net Income
Another component of interest rate risk is the effect changes in interest rates
will have on the fair value of our assets and our net income exclusive of the
effect on fair value. We face the risk that the fair value of our assets and net
investment income will increase or decrease at different rates than that of our
liabilities, including our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our
assets and the duration of our liabilities. Duration essentially measures the
market price volatility of financial instruments as interest rates change. We
generally calculate duration using various financial models and empirical data.
Different models and methodologies can produce different duration numbers for
the same securities.
The following sensitivity analysis table shows the estimated impact of our
interest rate-sensitive investments and repurchase agreement liabilities on the
fair value of our assets and our net income, exclusive of the effect of changes
in fair value on our net income, at September 30, 2012 and December 31, 2011,
assuming a static portfolio and that rates instantaneously fall 25, 50 and 75
basis points and rise 25, 50 and 75 basis points.

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September 30, 2012
                                                        Projected Change in
                           Projected Change in the            Our Net
Change in Interest Rates  Fair Value of Our Assets*           Income
- 75 basis points                      1.37  %                    9.15  %
- 50 basis points                      0.92  %                    7.32  %
- 25 basis points                      0.47  %                    3.66  %
No Change                                 -  %                       -  %
+ 25 basis points                     (0.44 )%                   (9.15 )%
+ 50 basis points                     (1.03 )%                  (18.31 )%
+ 75 basis points                     (1.78 )%                  (27.46 )%


December 31, 2011
                                                        Projected Change in
                           Projected Change in the            Our Net
Change in Interest Rates  Fair Value of Our Assets*           Income
- 75 basis points                      0.42  %                    5.52  %
- 50 basis points                      0.34  %                    4.41  %
- 25 basis points                      0.20  %                    2.18  %
No Change                                 -  %                       -  %
+ 25 basis points                     (0.39 )%                   (5.61 )%
+ 50 basis points                     (0.93 )%                  (11.17 )%
+ 75 basis points                     (1.59 )%                  (16.74 )%


_____________

* Analytics provided by The Yield Book® Software



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 take advantage or minimize the impact of changes in
interest rates. Additionally, the effects of interest rate changes on our
portfolio illustrated in the above chart do not take into account the effect
that our hedging instruments, mainly interest rate swaps and caps, would have on
the fair value of our portfolio, but do take into account the effect that our
hedging instruments, would have on our net income exclusive of the effect on
fair value. Generally, our interest rate swaps reset in the quarter following
changes in interest rates. It is important to note that the impact of changing
interest rates on fair value and net income can change significantly when
interest rates change beyond 75 basis points from current levels. Therefore, the
volatility in the fair value of our assets could increase significantly when
interest rates change beyond 75 basis points. In addition, other factors impact
the fair value of and net 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, in the event of changes in actual interest rates, the change in the
fair value of our assets and our net income would likely differ from that shown
above, and such difference might be material and adverse to our stockholders.
Risk Management
Our board of directors exercises its oversight of risk management in many ways,
including overseeing our senior management's risk-related responsibilities,
including reviewing management policies and performance against these policies
and related benchmarks.
As part of our risk management process, we actively manage the interest rate,
liquidity, prepayment and counterparty risks associated with our Agency RMBS
portfolio. We seek to mitigate our interest rate risk exposure by entering into
various hedging instruments in order to minimize our exposure to potential
interest rate mismatches between the interest we earn on our investments and our
borrowing costs.
We seek to mitigate our liquidity risks by monitoring our liquidity position on
a daily basis and maintaining a prudent level of leverage, which we currently
consider to be between six and 10 times the amount of net assets in our overall
portfolio, based on current market conditions and various other factors,
including the health of the financial institutions that lend to us under our
repurchase agreements and the presence of special liquidity programs provided by
domestic and foreign central banks.

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We seek to mitigate our prepayment risk by investing in Agency RMBS with (i) a
variety of prepayment characteristics, (ii) prepayment prohibitions and
penalties and (iii) prepayment protections, as well as by balancing Agency RMBS
purchased at a premium with Agency RMBS purchased at a discount.
We seek to mitigate our counterparty risk by (i) diversifying our exposure
across a broad number of counterparties, (ii) limiting our exposure to any one
counterparty and (iii)  monitoring the financial stability of our
counterparties.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our
Chief Financial Officer, evaluated the effectiveness of our disclosure controls
and procedures as of September 30, 2012. The term "disclosure controls and
procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), means controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by a company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the company's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation of our disclosure controls and procedures as of
September 30, 2012, our Chief Executive Officer and Chief Financial Officer
concluded that, as of such date, our disclosure controls and procedures were
effective.
There have been no changes in our internal controls over financial reporting
that occurred during the last fiscal quarter that have materially affected, or
are reasonably likely to materially affect, our internal controls over financial
reporting.
Wordcount: 14631



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