News Column

ARLINGTON ASSET INVESTMENT CORP. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 10, 2014

Overview

Arlington Asset Investment Corp. is a principal investment firm that currently acquires and holds primarily mortgage-related assets and holds certain other assets. We acquire residential mortgage-backed securities (MBS), either issued by U.S. government agencies or guaranteed as to principal and interest by U.S. government agencies or U.S. government-sponsored entities (agency-backed MBS). We also acquire MBS issued by private organizations (private-label MBS), subject to maintaining our exemption from regulation as an investment company under the Investment Company Act of 1940, as amended (1940 Act). In the future, we may acquire and hold other types of assets, including commercial MBS, asset backed securities, other structured securities, commercial mortgage loans, commercial loans, residential mortgage loans, and other real estate-related loans and securities. In addition, we also may pursue other business activities that will utilize our experience in analyzing investment opportunities and applying similar portfolio management skills.



When we use the terms "Arlington Asset," "AAIC," "we" "us" "our" and "the Company," we mean Arlington Asset Investment Corp. and its consolidated subsidiaries. We are a Virginia corporation and taxed as a C corporation for federal income tax purposes. We operate in the United States.

Factors that Affect our Results of Operations and Financial Condition

Our business is materially affected by a variety of industry and economic factors, including:

conditions in the global financial markets and economic conditions generally;

changes in interest rates and prepayment rates;

actions taken by the U.S. government, U.S. Federal Reserve and the U.S.

Treasury;

changes in laws and regulations and industry practices;

actions taken by ratings agencies with respect to the U.S.'s credit rating;

and

other market developments.

Adverse market conditions and actions by governmental authorities could adversely affect our business in many ways, including but not limited to making it more difficult for us to analyze our investment portfolio, reducing the market value of our MBS portfolio, adversely affecting our ability to maintain targeted amounts of leverage on our MBS portfolio and successfully implement our hedging strategy, and limiting our ability to follow our current investment and financing strategies. While uncertain, these potentially adverse market conditions and actions by governmental authorities may adversely affect our liquidity, financial position and results of operations. We have been and will continue to evaluate the potential impact of recent government actions, including developments relating to various state and federal government actions affecting the market price of MBS, related derivative securities, and interest rates. For further discussions on how market conditions and government actions may adversely affect our business, see "Item 1A - Risk Factors." Our MBS portfolio is affected by general U.S. residential real estate market conditions and the overall U.S. economic environment. In particular, our MBS strategy and the performance of our MBS portfolio is influenced by the specific characteristics of these markets, including prepayment rates, credit losses, interest rates and the interest rate yield curve. Our results of operations with respect to our MBS portfolio primarily depend on, among other things, the level of our interest income and the amount and cost of borrowings we 35 --------------------------------------------------------------------------------



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may obtain by pledging our investment portfolio as collateral for the borrowings. Our borrowing cost varies based on changes in interest rates and changes in the amount we can borrow, which is generally based on the fair value of the MBS portfolio and the advance rate the lenders are willing to lend against the collateral provided. The payment of principal and interest on the agency-backed MBS that we acquire and hold is guaranteed by the Federal Home Loan Mortgage Corporation (Freddie Mac) or the Federal National Mortgage Association (Fannie Mae). The payment of principal and interest on agency-backed MBS issued by Freddie Mac or Fannie Mae is not guaranteed by the U.S. government. Any failure to honor its guarantee of agency-backed MBS by Freddie Mac or Fannie Mae or any downgrade of securities issued by Freddie Mac or Fannie Mae by the rating agencies could cause a significant decline in the value of and cash flow from any agency-backed MBS we own that are guaranteed by such entity.



Current Market Conditions and Trends

In September 2012, the U.S. Federal Reserve announced a third round of quantitative easing, known as QE3, pursuant to which it would purchase additional agency-backed MBS at a pace of $40 billion per month until further notice. The U.S. Federal Reserve also announced that it would maintain its policy of reinvesting principal payments from its existing holdings of agency-backed MBS into new purchases of agency-backed MBS until the employment rate, among other economic indicators, showed signs of improvement. The U.S. Federal Reserve further stated that it would maintain the target range for the Federal Funds Rate between zero and 0.25% through at least mid-2015, which is six months longer than previously announced. The U.S. Federal Reserve provided further guidance to the market in December 2012 that it intended to keep the Federal Funds Rate close to zero while the unemployment rate is above 6.5% and as long as inflation does not rise above 2.5%. In December 2012, the U.S. Federal Reserve also announced that it would initially begin purchasing $45 billion of long-term U.S. Treasury bonds each month and noted that such amount may increase in the future. The economic news for the fourth quarter of 2013 was dominated by speculation over when the U.S. Federal Reserve would announce the tapering of QE3. On December 18, 2013, the U.S. Federal Reserve announced that it would reduce its purchases of agency-backed MBS by $5 billion per month and reduce its purchases of U.S. Treasury bonds by $5 billion per month beginning in January 2014. On January 29, 2014, the U.S. Federal Reserve announced that it would further reduce its purchases of agency-backed MBS by an additional $5 billion per month and further reduce its purchase of U.S. Treasury bonds by an additional $5 billion per month beginning in February 2014. These reductions, collectively, are commonly referred to as "tapering." Given the low inflation projections, the U.S. government's monetary policy, including the timing of tapering asset purchases, will likely be dependent on actual growth in employment rather than inflation concerns. It's important to note that over the past several years, actual employment growth has been consistently below the U.S. Federal Reserve's projections. While there are signs of a recovery, uncertainty continues to dominate the market, due to the continued low interest rate environment and actions by the U.S. Federal Reserve. We believe the general business environment will continue to be challenging in 2014 and future periods. Our growth outlook is dependent, in part, on the strength of the financial markets, the impact of fiscal and monetary policy actions by the United States and other countries, the overall market value of U.S. equities and liquidity in the financial system. Depending on recent market developments and movements, we may seek to re-align our strategy and our portfolio. We will continue to closely monitor the developments in the market and evaluate the opportunities across the spectrum in the mortgage industry and other types of assets and seek the highest risk-adjusted returns for our capital. We believe the limited liquidity and volatility in the credit markets will continue while the markets seek to determine the right equilibrium levels for benchmark interest rates as the U.S. Federal Reserve stimulus leaves the market place. Recent Government Activity



On June 25, 2013, Senators Bob Corker (R-TN) and Mark Warner (D-VA), with Senators Mike Johanns (R-NE), Jon Tester (D-MT), Dean Heller (R-NV), Heidi Heitkamp (D-ND), Jerry Moran (R-KS) and Kay Hagan (D-NC) formally introduced the Housing Finance Reform and Taxpayer Protection Act of 2013

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(Corker-Warner Bill) into the U.S. Senate. While the current draft of the Corker-Warner Bill will likely undergo significant changes as it is debated, it is expected to serve as a basis of discussion for congressional efforts to reform Fannie Mae and Freddie Mac.

As currently drafted, the Corker-Warner Bill has three key provisions:

the establishment of the Federal Mortgage Insurance Corporation (the FMIC);

the creation of a Mortgage Insurance Fund (the Fund); and

the wind-down of Fannie Mae and Freddie Mac.

The FMIC would be a government guarantor modeled after the Federal Deposit Insurance Corporation (FDIC) in that it would collect insurance premiums and maintain a deposit fund on all outstanding obligations. Every mortgage-backed security issued through the FMIC would have a private investor bearing the first risk of loss and holding at least $0.10 in equity capital for every dollar of risk. This private capital buffer would serve to protect taxpayers from the risk of default on the mortgages underlying securities issued by the FMIC. Thus, the ultimate purpose of the FMIC would be to bring in credit investors to bear the risk of default while providing liquidity, transparency and access to mortgage credit for the housing finance system. The Federal Housing Finance Authority (FHFA) would be abolished after the establishment of the FMIC, and all current responsibilities of the FHFA, as well as its resources, would be transferred to the FMIC. In particular, the Corker-Warner Bill specifies that the FMIC would maintain a database of uniform loan-level information on eligible mortgages, develop standard uniform securitization agreements and oversee the common securitization platform currently being developed by the FHFA. In the event losses due to default on underlying mortgages exceed the first position losses of private credit investors in securities issued by the FMIC, the FMIC would cover such losses out of the Fund. The Corker-Warner Bill specifies that the FMIC would endeavor to attain a reserve balance of 1.25% of the aggregate outstanding principal balance of covered securities within five years of the establishment of the FMIC and 2.50% of such amount within ten years of the establishment of the FMIC. The Fund would be paid with insurance premiums, akin to user fees, paid by private investors with various reporting and transparency requirements.



As currently proposed, the Corker-Warner Bill would revoke the charters of Fannie Mae and Freddie Mac upon the establishment of the FMIC. Fannie Mae and Freddie Mac would wind down as expeditiously as possible while maximizing returns to taxpayers as their assets are sold off.

On November 25, 2013, the FHFA issued a progress report with regards to the goals set forth in the FHFA White Paper and the Strategic Plan for Enterprise Conservatorships. The report stated that significant progress had been made on the development and testing of a common securitization platform for Fannie Mae and Freddie Mac and that both entities had contracted the less liquid portions of their portfolios. Despite this progress, the report conceded that significant impediments to the full realization of the FHFA's stated goals remain. If such goals are achieved, it is unclear what the effects might be. There is no way to know if either proposal will become law or should one of the proposals become law if and how the enacted law will differ from the current draft of the bill. It is unclear how this proposal would impact housing finance, and what impact, if any, it would have on companies that invest in MBS. The passage of any new legislation affecting Fannie Mae and Freddie Mac may create market uncertainty and reduce the actual or perceived credit quality of securities issued or guaranteed by the U.S. government through a new or existing successor entity to Fannie Mae and Freddie Mac. If the charters of Fannie Mae and Freddie Mac were revoked, it is unclear what effect, if any, this would have on the value of the existing Fannie Mae and Freddie Mac agency-backed MBS. It is also possible that the above-referenced proposed legislation, if made law, could adversely impact the market for securities issued or guaranteed by the U.S. government and the spreads at which they trade. The foregoing could materially adversely affect the pricing, supply, liquidity and value of our target assets and otherwise materially adversely affect our business, operations and financial condition. 37

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TABLE OF CONTENTS Executive Summary Given the uncertainty around the U.S. Federal Reserve policies and reversal or tapering of QE3, coupled with uncertainly regarding the ability of U.S. lawmakers to reach an agreement on the national debt ceiling, the market in 2013 was characterized by increased market and interest rate volatility. As a result, we experienced increased fluctuations in our asset prices and hedge positions during the year ended December 31, 2013. Current economic indicators and trends in underlying credit and housing data suggests continued improvement in 2014. We will continue to review the allocation of our available capital to maximize return to our shareholders. During the year ended December 31, 2013, we continued to raise additional capital through equity and debt offerings. On March 13, 2013, we completed a public offering of 3,450,000 shares of Class A common stock, including 450,000 shares of Class A common stock purchased by the underwriters pursuant to an option granted by us to cover over-allotments, at a public offering price of $25.50 per share, for net proceeds of $87.0 million after deducting underwriting discounts and commissions and expenses. On May 1, 2013, we completed a public offering of $25.0 million aggregate principal amount of 6.625% Senior Notes due 2023 (Senior Notes) and received net proceeds of approximately $24.0 million after payment of underwriting commissions and expenses. The Senior Notes will mature on May 1, 2023, and may be redeemed in whole or in part at any time and from time to time at our option on or after May 1, 2016 at a redemption price equal to the principal amount redeemed plus accrued and unpaid interest. The interest payments on the Senior Notes are payable quarterly on February 1, May 1, August 1, and November 1 of each year. We believe that our MBS portfolio continued to perform well during the year ended December 31, 2013. The overall value of our agency-backed MBS portfolio increased, primarily as a result of increased acquisitions of agency-backed MBS with proceeds of the offerings invested on a leveraged basis, QE3, and the low interest rate environment, and the value of our private-label MBS portfolio held steady, primarily from an expected improvement in credit performance in general. As discussed above, unlike the prior quantitative easing programs, QE3 is more open-ended which we consider a significant change. This has affected MBS products by increasing the price of these bonds. However, these actions by the U.S. Federal Reserve have caused some concern that the effect of lower borrowing costs will increase the prepayments of the existing MBS population. This in turn, has caused MBS with prepayment protection attributes, such as most of our MBS positions, to increase in value. While we benefit from the increase in price, it may result in decreases in yields and net spread. Following its December 18, 2013 announcement that it would reduce its purchases of agency-backed MBS by $5 billion per month and reduce its purchases of U.S. Treasury bonds by $5 billion per month, the U.S. Federal Reserve on January 29, 2014, announced that it would further reduce its purchases of agency-backed MBS by an additional $5 billion per month and further reduce its purchase of U.S. Treasury bonds by an additional $5 billion per month. While we have not seen an immediate effect of these announcements on the value of our MBS portfolio, the longer term impact is not yet known. We will continue to monitor the market movements and impact on our MBS portfolio. Continued expectations of stabilization and improvement in the housing market, increased liquidity and available leverage have stabilized prices for our private-label MBS, particularly among re-REMIC mezzanine securities. Our re-REMIC securities are predominantly held in the subordinate tranches. We will continue to closely monitor the performance of these securities. Based on the improvements we have observed in the general economic indicators and trends in underlying credit and housing data, we have reallocated some of our available capital to the private-label MBS portfolio during the year. We continued to evaluate the opportunities across the MBS industry and seek the highest risk-adjusted returns for our capital, and to strengthen our position and to maximize return to our shareholders. We evaluated and prioritized the risk-adjusted return we expect to receive on every asset based upon a current cash yield perspective as well as from a total yield perspective that includes expected reflation, which is defined as an increase in value between the amortized cost basis and the par value of the security. Historically, based on market conditions, we believe our MBS assets have provided us with higher relative risk-adjusted rates of return than most other portfolio opportunities we have evaluated. We intend to continue to evaluate acquisition opportunities against the returns available in each of our asset alternatives and endeavor to allocate our assets and capital with an emphasis toward what we believe will generate the highest risk-adjusted return available. This strategy may cause us to have different allocations of capital in different 38 --------------------------------------------------------------------------------



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environments. We believe we have constructed an MBS portfolio with attractive characteristics and will continue to monitor relative value between the various classes of MBS and may re-allocate our portfolio at any time based on management's view of the market. We also believe the strategy of maintaining our combined portfolio, agency-backed MBS and private-label MBS, allows us to mitigate risk exposures in a sometimes unexpected and volatile environment. Effective December 31, 2013, we contributed 40 of our private-label MBS with $367.6 million in face value in a taxable contribution (Contribution) to Rosslyn REIT Trust. Rosslyn REIT Trust (formerly known as FBR REIT Asset Trust) was formed on December 27, 2007 as a Maryland real estate investment trust and will elect to be taxed as a REIT for U.S. federal income tax purposes effective January 1, 2014. We own all the common shares of Rosslyn REIT Trust and all of the preferred shares are owned by outside investors. The Contribution resulted in taxable capital gains of $68.0 million. We utilized NCL carry-forwards to offset the capital gain recognized on the Contribution for tax purposes. As of December 31, 2013, we had net deferred tax assets of $165.9 million, net of $15.9 million in valuation allowance on our deferred tax assets attributable to NCLs that are expected to expire in 2014. Our evaluation of the reasonableness of our valuation allowance on deferred tax assets is an on-going process. The evaluation includes an assessment of both the positive and negative evidences such as historical results of operations and future projections, the size of the MBS portfolio, net yield and comparison of management's forecasts to actual results. For the year ended December 31, 2013, we determined that the positive evidences described below out-weighed the negative evidences and that it is more-likely-than-not that the deferred tax assets will be realized based on our forecast of future net income, which provides support for not recording the valuation allowance on certain deferred tax assets resulted from NOLs and other temporary items. We have generated taxable income of $31.0 million, $45.6 million, and $47.2 million during the years ended December 31, 2011, 2012, and 2013, respectively, demonstrating a positive and consistent earnings trend over the three year period ended December 31, 2013. We cannot assure you, however, that these deferred tax assets will in fact be realized. See "Item 1A - Risk Factors - Future decreases in the Company's book value attributable to deferred tax assets may reduce the market price of our shares." in this Annual Report on Form 10-K. Our book value per share of $33.10 as of December 31, 2013 reflects $9.95 per share related to the deferred tax assets on our balance sheet. As we benefit from the utilization of the deferred tax assets in future periods or those deferred tax assets expire without being utilized, the corresponding book value attributable to the deferred tax assets utilized will be reduced by the same amount and the reported GAAP net income will also be reduced for the corresponding income tax effect. As we previously disclosed, we are subject to examination by the U.S. Internal Revenue Service (IRS), and other taxing jurisdictions. In March 2013, an IRS examination of the tax years 2009 and 2010 was completed without any adjustment. With the completion of the IRS examination and the expiration of the statute of limitation on the 2009 state tax return, we reversed $12.8 million of unrecognized tax benefits related to an uncertain tax position and $3.4 million of related accrued interest during the year ended December 31, 2013. During the preparation of the 2013 consolidated financial statements, we concluded that the federal tax rate used to calculate deferred tax assets as of December 31, 2012 was incorrect and should have been lower than the statutory rate given the effects of recognizing a U.S. federal deferred income tax liability associated with state deferred tax assets. Although the impact of this change was not material to the consolidated financial statements as of and for the year ended December 31, 2012, we revised our previously reported consolidated financial statements and disclosures as of and for the year ended December 31, 2012. See Note 10, "Revisions to Previously Reported Financial Statements," of Notes to Consolidated Financial Statements included elsewhere in this Report on Form 10-K. For the year ended December 31, 2013, we had net income of $49.5 million, or $3.06 per share (diluted), compared to $183.9 million, or $17.96 per share (diluted), for the year ended December 31, 2012. As of December 31, 2013, our book value per share was $33.10. In addition to the release of $91.2 million and $162.5 million, respectively, of valuation allowance on certain deferred tax assets that was included in net income during the years ended December 31, 2013 and 2012, our net income includes net interest income of 39 --------------------------------------------------------------------------------



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$78.5 million for the year ended December 31, 2013 compared to net interest income of $59.2 million for the year ended December 31, 2012. Our other expenses decreased to $16.6 million during the year ended December 31, 2013 compared to $17.4 million for the year ended December 31, 2012.



The following is a summary of our net income for the periods indicated:

[[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, (Dollars in thousands) 2013 2012 2011 Net interest income $ 78,490 $ 59,189 $ 50,037 Other loss, net (47,760 ) (10,738 ) (19,180 ) Other expenses 16,591 17,446 14,189 Income before income 14,139 31,005 16,668 taxes Income tax (benefit) (35,322 ) (152,937 ) 1,495 provision Net income $ 49,461$ 183,942$ 15,173 In addition to the financial results reported in accordance with generally accepted accounting principles as consistently applied in the United States (GAAP), we calculated non-GAAP core operating income for the years ended December 31, 2013 and 2012. Our non-GAAP core operating income for the years ended December 31, 2013 and 2012 was $67.2 million and $50.3 million, respectively. In determining core operating income, we excluded certain legacy litigation expenses and the following non-cash expenses: (1) compensation costs associated with stock-based awards, (2) accretion of MBS purchase discounts adjusted for contractual interest and principal repayments in excess of proportionate invested capital, (3) unrealized mark-to-market adjustments on the trading MBS and hedge instruments, (4) other-than-temporary impairment charges recognized, (5) non-cash income tax provisions, and (6) benefit from the reversal of previously accrued federal and state tax liability and accrued interest related to uncertain tax positions. This non-GAAP measurement is used by management to analyze and assess the operating results and dividends. We believe that this non-GAAP measurement assists investors in understanding the impact of these non-core items and non-cash expenses on our performance and provides additional clarity around our forward earnings capacity and trends. A limitation of utilizing this non-GAAP measure is that the GAAP accounting effects of these events do in fact reflect the underlying financial results of our business and these effects should not be ignored in evaluating and analyzing our financial results. Therefore, we believe net income on a GAAP basis and core operating income on a non-GAAP basis should be considered together. The following is a reconciliation of GAAP net income to non-GAAP core operating income for the years ended December 31, 2013 and 2012 (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2013 2012 GAAP net income $ 49,461$ 183,942 Adjustments Legacy litigation expenses(1) 1,061 2,627 Stock compensation 2,546 998 Non-cash interest income related to (4,743 ) (5,644 ) purchase discount accretion(2) Net unrealized mark-to-market loss on 53,812



7,352

trading MBS and hedge instruments Other-than-temporary impairment charges 1,354



15,708

Release of valuation allowance on deferred tax assets and non-cash income tax (20,051 ) (154,635 ) provisions and benefit, net Benefit from the reversal of tax liability and accrued interest related to uncertain (16,212 )



-

tax position Non-GAAP core operating income $ 67,228 $ 50,348 [[Image Removed]]



(1) Legacy litigation expenses relate to legal matters pertaining to events

related to business activities the Company completed or exited in or prior

to 2009 - primarily debt extinguishment, sub-prime mortgage origination and

securitization and broker/dealer operations.

(2) Non-cash interest income related to purchase discount accretion represents

interest income recognized in excess of cash receipts related to contractual

interest income and principal repayments in excess of proportionate invested

capital. 40

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As of December 31, 2013, our agency-backed MBS consisted of $1.5 billion in face value with a cost basis of $1.6 billion and was fair valued at $1.6 billion. Our agency-backed MBS had a weighted-average coupon of 4.08% and a weighted-average cost of funding of 0.39% at December 31, 2013. During the year ended December 31, 2013, we received proceeds of $914.2 million from the sale of $861.1 million in face value of our agency-backed MBS, realizing $25.8 million in net losses, or realized net losses of $16.2 million from the acquisition price. In the normal course of our operations, we utilize financial instruments to hedge economic risk. These instruments may include interest rate swaps, Eurodollar futures, swap futures, and U.S. Treasury futures contracts, put options and certain commitments to purchase and sell MBS. The 10-year swap futures are uniquely designed to replicate the over-the-counter swap economics and are valued based upon the difference between a series of semi-annual fixed interest payments and quarterly floating interest payments based on the 3-month U.S. Dollar LIBOR rate, over the term to maturity. While 10-year swap futures mature or roll on a quarterly basis, the change in value represents the impact of the change in the underlying interest indices during the term. As a result, the 10-year swap futures exhibit longer duration and are sensitive to changes in interest rates. Due to the shorter term maturity, the fluctuations in the value of these derivatives may be volatile and are included in GAAP income as unrealized gains or losses until such time as they are terminated or expire, whereupon they are included in GAAP income as realized gains or losses and Non-GAAP core operating income as gains or losses. We have entered into Eurodollar futures to mitigate the interest rate sensitivity which directly impacts our cost of borrowing and the market value of our agency-backed MBS. The Eurodollar futures mature through September 30, 2018 and have a lifetime weighted-average rate of 2.93%, as compared to a lifetime weighted-average market rate of 2.25% as of December 31, 2013. The value of these five-year hedge instruments is expected to fluctuate inversely relative to the agency-backed MBS portfolio and decrease in value during periods of declining interest rates and/or widening mortgage spreads. Conversely, during periods of increasing rates and/or tightening mortgage spreads, these instruments are expected to increase in value. The cost of these Eurodollar hedges will increase over their five-year term. The swap futures mature in March 2014 and have a weighted-average rate of 3.14%, as compared to a weighted-average market rate of 3.19% as of December 31, 2013. As of December 31, 2013, our private-label MBS portfolio consisted of $485.9 million in face value with an amortized cost basis of $278.7 million and was fair valued at $341.3 million. The unamortized net discount on our private-label MBS portfolio was $207.2 million as of December 31, 2013. During the year ended December 31, 2013, we recognized net interest income of $25.5 million, representing a 10.3% annualized yield, including coupon and accretion of purchase discount based on the current accretable yield rate, from our private-label MBS portfolio. During 2013, we received proceeds of $69.3 million from the sale of $102.1 million in face value of our private-label MBS, realizing $17.5 million in gains. For available-for-sale, private-label MBS securities that have been acquired at discounts to face value due in part to credit deterioration since origination, we re-evaluate the undiscounted expected future cash flows and the changes in cash flows from those originally projected at the time of purchase or last revised for each security. For those securities in an unrealized loss position, we recognized $1.3 million and $0.1 million in other-than-temporary impairment (OTTI) charges on our private-label MBS portfolio and on an investment in agency interest-only MBS, respectively, during 2013. The OTTI charges represent the difference between the carrying value and the net present value of expected future cash flows discounted using the current yield used for income recognition purposes, as compared to fair value which is discounted using the current expected market rate in accordance with GAAP for the securities acquired at discount due to credit deterioration since origination. As a result, the OTTI charges are greater than the difference between the carrying value and fair value. These OTTI charges do not represent additional credit deterioration but the change in timing of cash flow projection primarily due to higher than projected actual cash flows during the earlier periods. In addition, these OTTI charges do not affect non-GAAP core operating income or book value, but do reduce our net income and lower the accounting basis used to record future discount accretion. 41 --------------------------------------------------------------------------------



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Principal Investing Portfolio

The following table summarizes our principal investing portfolio including principal receivable on MBS, as of December 31, 2013 (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Face Amount Fair Value Trading Agency-backed MBS Fannie Mae $ 961,360 $ 997,488 Freddie Mac 561,307 578,964 Available-for-sale Agency-backed MBS Fannie Mae 43 47 Private-label MBS Senior securities 10,201 7,066 Re-REMIC securities 475,714 334,233 Other mortgage related assets 76,305 298 Total $ 2,084,930$ 1,918,096 Operating Income



Our operating income consists primarily of net interest income, net investment gains and losses, and investment fund earnings.

Expenses

Interest expense includes the costs of our repurchase agreement borrowings and long-term debt securities.

Compensation and benefits expense includes base salaries as well as incentive compensation. Salaries, payroll taxes and employee benefits are relatively fixed in nature. In addition, compensation and benefits expense includes estimated performance-based incentive compensation, including the discretionary component that is more likely-than not to be paid and non-cash expenses associated with all stock-based awards granted to employees.



Professional services expense includes accounting, legal and consulting fees. Many of these expenses, such as legal fees, are to a large extent variable related to level of transactions, ongoing litigation and initiatives.

Business development expense includes primarily travel and entertainment expenses.

Occupancy and equipment expense includes rental costs for our facilities and depreciation and amortization of equipment and software. These expenses are largely fixed in nature.

Communications expenses include voice, data and internet service fees, and data processing costs.

Other operating expenses include professional liability and property insurance, directors' fees including cash and stock awards, printing and copying, business licenses and taxes, offices supplies, penalties and fees, charitable contributions and other miscellaneous office expenses, if any. 42 --------------------------------------------------------------------------------

TABLE OF CONTENTS Results of Operations Comparison of the years ended December 31, 2013 and 2012 We reported net income of $49.5 million for the year ended December 31, 2013 compared to $183.9 million for the year ended December 31, 2012. Net income included the following results for the periods indicated (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2013 2012 Interest income $ 87,019 $ 64,154 Interest expense 8,529 4,965 Net interest income 78,490 59,189 Other loss, net Investment loss, net (47,745 ) (10,723 ) Other loss (15 ) (15 ) Total other loss, net (47,760 ) (10,738 ) Other expenses 16,591 17,446 Income before income taxes 14,139 31,005 Income tax benefit (35,322 ) (152,937 ) Net income $ 49,461$ 183,942 Net income decreased $134.4 million to $49.5 million for the year ended December 31, 2013 from $183.9 million for the year ended December 31, 2012. The decrease in net income is due to the following changes:



Net Interest Income

Net interest income increased $19.3 million (32.6%) to $78.5 million for the year ended December 31, 2013 from $59.2 million for the year ended December 31, 2012. The increase is primarily the result of fully deploying our investable capital generated from the capital raised from our public offerings in 2013 on a leveraged basis to our MBS portfolio. The components of income from our principal investment activities, net of related interest expense are as follows (dollars in thousands):



[[Image Removed]] [[Image Removed]] [[Image Removed]]

Year Ended December 31, 2013 2012 Net interest income $ 80,120$ 59,679 Investment loss, net (47,745 ) (10,723 )



The components of net interest income from our MBS related portfolio is summarized in the following table (dollars in thousands):

[[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2013 2012 Average Balance Income (Expense) Yield Average Balance Income (Expense) Yield (Cost) (Cost) Agency-backed MBS $ 1,599,589$ 60,386 3.78 % $ 971,725 $ 39,705 4.09 % Private-label MBS Senior securities 5,435 893 16.43 % 7,787 1,319 16.94 % Re-REMIC 241,880 25,693 10.62 % 140,890 23,007 16.33 % securities Other investments 427 44 10.37 % 1,054 122 11.57 % $ 1,847,331 87,016 4.71 % $ 1,121,456 64,153 5.72 % Other(1) 3 1 87,019 64,154 Repurchase $ 1,515,137 (6,899 ) (0.45 )% $ 953,152 (4,475 ) (0.46 )% agreements Net interest $ 80,120 4.26 % $ 59,679 5.26 % income/spread [[Image Removed]]



(1) Includes interest income on cash and other miscellaneous interest-earning

assets. 43

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The increase in net interest income of $20.4 million is primarily due to the increases in our MBS portfolio from the deployment of capital raised from our public offerings during 2012 and 2013 on a leveraged basis. The decreases in interest rates in the MBS portfolio and related repurchase agreements did not materially impact the change in net interest income for the year ended December 31, 2013 from the year ended December 31, 2012. Interest income from other investments represents interest on interest-only MBS securities. Interest expense related to repurchase agreements increased $2.4 million (53.3%) to $6.9 million for the year ended December 31, 2013 from $4.5 million for the year ended December 31, 2012 due to the increase in the repurchase agreement borrowings. Our repurchase borrowings increased primarily as a result of leveraging the net proceeds raised from our public offerings of common stock in 2013 in connection with the investment of such net proceeds. Interest expense unrelated to our principal investing activity relates to long-term debt. These costs increased to $1.6 million for the year ended December 31, 2013 from $0.5 million for the year ended December 31, 2012 due to the increase in long-term debt outstanding as a result of the Senior Notes.



Other Loss, Net

Total other loss, net, increased $37.1 million to a loss of $47.8 million for the year ended December 31, 2013 from a loss of $10.7 million for the year ended December 31, 2012 primarily due to an increase in net investment losses as follows (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2013 2012 Realized gains on sale of $ 17,458 $ 9,813 available-for-sale investments, net Available-for-sale and cost method (1,354 ) (15,708 ) securities - OTTI charges (Losses) gains on trading investments, net (122,163 )



22,280

Gains (losses) from derivative instruments, 58,003 (28,755 ) net Other, net 311 1,647 Investment loss, net $ (47,745 )$ (10,723 ) The realized gains on sale of available-for-sale investments, net, recognized for the year ended December 31, 2013 and 2012 were primarily the result of $69.3 million and $34.1 million of proceeds received, respectively, from the sales of $102.1 million and $53.5 million in face value of MBS, respectively. We recorded a net gain of $17.5 million and $9.8 million from these sales for the years ended December 31, 2013 and 2012, respectively. We recorded OTTI charges of $1.3 million and $15.2 million for the years ended December 31, 2013 and 2012, respectively, on available-for-sale, private-label MBS, with a cost basis of $11.7 million and $49.4 million, respectively. The OTTI charges represent the difference between the carrying value and the net present value of expected future cash flows discounted using the current yield used for income recognition purposes, as compared to fair value which is discounted using the current expected market rate in accordance with GAAP for the securities acquired at discount due to credit deterioration since origination. These OTTI charges do not represent additional credit deterioration but the change in timing of cash flow projection primarily due to higher than projected actual cash flows during the earlier periods. For the years ended December 31, 2013 and 2012, we recorded OTTI charges of $0.1 million and $0.5 million, respectively, on an investment in agency interest-only MBS. The losses on trading investments, net, recognized for the year ended December 31, 2013 were primarily the result of net losses of $25.8 million from sales and net mark-to-market loss adjustments of $96.4 million. The losses on trading investments, net, recognized for the year ended December 31, 2013, also reflects net realized losses of $16.2 million on the sold securities from the acquisition price and changes in net unrealized mark-to-market loss adjustments of $106.0 million during the year. The gains on trading investments, net, recognized for the year ended December 31, 2012 were primarily the result of net gains of $4.8 million from sales and net mark-to-market gain adjustments of $17.5 million. The gains on trading investments, net, 44 --------------------------------------------------------------------------------



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recognized for the year ended December 31, 2012, also reflects net realized gains of $15.3 million on the sold securities from the acquisition price and changes in net unrealized mark-to-market gain adjustments of $7.0 million during the year. The gains from derivative instruments recognized for the year ended December 31, 2013 were the result of net realized gains of $45.4 million and net unrealized mark-to-market gain adjustments of $12.6 million. Gains from derivative instruments recognized for the year ended December 31, 2013 also reflects net gains of $5.9 million from closed derivative instruments from the acquisition price and changes in net unrealized mark-to-market gain adjustments of $52.1 million during the year. Losses from derivative instruments recognized for the year ended December 31, 2012 were the result of net realized losses of $2.3 million and net unrealized mark-to-market loss adjustments of $26.5 million. Losses from derivative instruments recognized for the year ended December 31, 2012 also reflects net losses of $14.7 million from closed derivative instruments from the acquisition price and changes in net unrealized mark-to-market loss adjustments of $14.1 million during the year. The value of our hedge instruments is expected to fluctuate inversely relative to the change in value of the agency-backed MBS portfolio. Other, net primarily reflects proceeds received from the assignment of a claim that related to an agency-backed MBS under a repurchase agreement maintained with Lehman Brothers Inc. during the Lehman Brothers Holdings Inc. bankruptcy proceedings for the year ended December 31, 2012.



Other Expenses

Other expenses decreased by $0.8 million (4.6%) from $17.4 million for the year ended December 31, 2012 to $16.6 million for the year ended December 31, 2013. The decrease is primarily a result of decreases in legal expenses offset by increases in compensation expenses.



Income Tax Benefit

Total income tax benefit decreased from a benefit of $152.9 million for the year ended December 31, 2012 to a benefit of $35.3 million for the year ended December 31, 2013. The decrease in income tax benefit was due primarily to: $91.2 million in release of valuation allowance on certain deferred tax assets offset by an expiration of $57.3 million of NCL carry-forwards; reversal of $16.2 million in reserve for federal and state tax benefits and related accrued interest related to an uncertain tax position; and $14.4 million of other changes in deferred tax assets for the year ended December 31, 2013 as compared to $162.5 million in release of valuation allowance on certain deferred tax assets for the year ended December 31, 2012. As a result, our effective tax rate during years ended December 31, 2013 and 2012 were lower than the statutory tax rate. The net deferred tax assets, which are partially offset by a valuation allowance, include NOLs, which are available to offset the current and future taxable income. We recorded an expected tax liability for the period due to the expected alternative minimum taxes.



Comparison of the years ended December 31, 2012 and 2011

We reported net income of $183.9 million for the year ended December 31, 2012 compared to $15.2 million for the year ended December 31, 2011. Net income included the following results for the periods indicated (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2012 2011 Interest income $ 64,154 $ 52,545 Interest expense 4,965 2,508 Net interest income 59,189 50,037 Other loss, net Investment loss, net (10,723 ) (19,166 ) Other loss (15 ) (14 ) Total other loss, net (10,738 ) (19,180 ) Other expenses 17,446 14,189 Income before income taxes 31,005 16,668 Income tax (benefit) provision (152,937 ) 1,495 Net income $ 183,942$ 15,173 45

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Net income increased $168.7 million to $183.9 million for the year ended December 31, 2012 from $15.2 million for the year ended December 31, 2011 primarily due to the release of $162.5 million in the valuation allowance on certain deferred tax assets as previously discussed and the following changes:

Net interest income increased $9.2 million (18.4%) to $59.2 million for the year ended December 31, 2012 from $50.0 million for the year ended December 31, 2011. The increase is primarily the result of fully deploying our investable capital on a leveraged basis to our MBS portfolio. See additional yield analysis below. Investment loss, net, decreased $8.5 million to a loss of $10.7 million for the year ended December 31, 2012 from a loss of $19.2 million for the year ended December 31, 2011. See below for additional discussion on the components of investment gains and losses for the respective periods. The following table summarizes the components of income from our principal investment activities, net of related interest expense (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2012 2011 Net interest income $ 59,679$ 50,502 Investment loss, net (10,723 ) (19,166 )



The components of net interest income from our MBS related portfolio is summarized in the following table (dollars in thousands):

[[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2012 2011 Average Balance Income (Expense) Yield (Cost) Average Balance Income (Expense) Yield (Cost) Agency-backed MBS $ 971,725 $ 39,705 4.09 % $ 556,097 $ 24,931 4.48 % Private-label MBS Senior securities 7,787 1,319 16.94 % 13,676 1,750 12.80 % Re-REMIC 140,890 23,007 16.33 % 136,500 25,421 18.62 % securities Other investments 1,054 122 11.57 % 1,923 278 14.48 % $ 1,121,456 64,153 5.72 % $ 708,196 52,380 7.40 % Other 1 165 64,154 52,545 Repurchase $ 953,152 (4,475 ) (0.46 )% $ 559,086 (2,043 ) (0.36 )% agreements Net interest $ 59,679 5.26 % $ 50,502 7.04 % income/spread The change in the composition of our MBS portfolio and related increase in net interest income by $9.2 million from the year ended December 31, 2011 to the year ended December 31, 2012 was primarily due to the deployment of capital raised from our public offerings during the year ended December 31, 2012 primarily into our agency-backed MBS portfolio. Interest income from other investments represents interest on interest-only MBS securities. 46 --------------------------------------------------------------------------------



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As discussed above, we reported net investment loss of $10.7 million for the year ended December 31, 2012 compared to reported net investment loss of $19.2 million for the year ended December 31, 2011. The following table summarizes the components of net investment loss (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] Year Ended December 31, 2012 2011 Realized gains on sale of $ 9,813 $ 14,894 available-for-sale investments, net Available-for-sale and cost method securities - other-than-temporary (15,708 ) (1,223 ) impairment charges Gains on trading investments, net 22,280



31,837

Losses from derivative instruments, net (28,755 ) (64,625 ) Other, net 1,647 (49 ) Investment loss, net $ (10,723 )$ (19,166 ) We recorded other-than-temporary impairment charges of $15.2 million and $1.2 million for the year ended December 31, 2012 and 2011, respectively, related to changes in expected credit performance on available-for-sale, private-label MBS, with a cost basis of $49.4 million and $11.1 million, respectively, prior to recognizing the other-than-temporary impairment charges. For the year ended December 31, 2012, we recorded other-than-temporary impairment charges of $0.5 million on an investment in interest-only MBS. No other-than-temporary impairment charges on investments in interest-only MBS were recognized during the year ended December 31, 2011. The realized gains on sale of available-for-sale investments, net, recognized for the year ended December 31, 2012 and 2011 were primarily the result of $34.1 million and $79.2 million of proceeds received, respectively, from the sales of $53.5 million and $119.0 million in face value of MBS, respectively. We recorded a net gain of $9.8 million and $13.0 million from these sales for the year ended December 31, 2012 and 2011, respectively. We also realized net gains from the sale of other investments of $1.9 million for the year ended December 31, 2011. The gains on trading investments, net, recognized for the year ended December 31, 2012 were primarily the result of net gains of $4.8 million from sales and net mark-to-market gain adjustments of $17.5 million. The gains on trading investments, net, recognized for the year ended December 31, 2012, also reflects net realized gains of $15.3 million on the sold securities from the acquisition price and changes in net unrealized mark-to-market gain adjustments of $7.0 million during the year. The gains on trading investments, net, recognized for the year ended December 31, 2011 were primarily the result of net gains of $3.9 million from sales and net mark-to-market gain adjustments of $27.9 million. The gains on trading investments, net, recognized for the year ended December 31, 2011, also reflects net realized gains of $3.1 million on the sold securities from the acquisition price and changes in net unrealized mark-to-market gain adjustments of $28.7 million during the year. Losses from derivative instruments recognized for the year ended December 31, 2012 were the result of net realized losses of $2.3 million and net unrealized mark-to-market loss adjustments of $26.5 million. Losses from derivative instruments recognized for the year ended December 31, 2012 also reflects net losses of $14.7 million from closed derivative instruments from the acquisition price and changes in net unrealized mark-to-market loss adjustments of $14.1 million during the year. Losses from derivative instruments recognized for the year ended December 31, 2011 were the result of net realized losses of $4.5 million and net unrealized mark-to-market loss adjustments of $60.1 million. Losses from derivative instruments recognized for the year ended December 31, 2011 also reflects net gains of $3.3 million from closed derivative instruments from the acquisition price and changes in net unrealized mark-to-market loss adjustments of $67.9 million during the year ended December 31, 2011. The value of our hedge instruments is expected to fluctuate inversely relative to the change in value of the agency-backed MBS portfolio. Other, net primarily reflects proceeds received from the assignment of a claim that related to an agency-backed MBS under a repurchase agreement maintained with Lehman Brothers Inc. during the Lehman Brothers Holdings Inc. bankruptcy proceedings for the year ended December 31, 2012. 47 --------------------------------------------------------------------------------



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Interest expense unrelated to our principal investing activity relates to long-term debt. We recognized interest expense costs of $0.5 million for the years ended December 31, 2012 and 2011.

Other expenses increased by $3.2 million (22.5%) from $14.2 million for the year ended December 31, 2011 to $17.4 million for the year ended December 31, 2012 primarily as a result of an increase in legal costs related to the SEC inquiry and Hildene litigation. The both cases have been resolved favorably without material financial impact. Total income tax benefit increased from a provision of $1.5 million for the year ended December 31, 2011 to a benefit of $152.9 million for the year ended December 31, 2012 primarily as a result of the release of $162.5 million in valuation allowance on certain deferred tax assets. Our effective tax rate was 9.0% for the year ended December 31, 2011 as compared to (493.3)% for the same period in 2012. During the years ended December 31, 2012 and 2011, ordinary taxable income was subject to alternative minimum tax. Our effective tax rates during these periods differed from statutory rates primarily due to the expected use of federal and state net operating losses (NOLs) to offset our taxable income earned during those periods. Our NOLs had been recorded as deferred tax assets. We recorded an expected tax liability for these periods due to taxable income for the years ended December 31, 2012 and 2011 that is anticipated to be subject to the alternative minimum tax. Limitations prevent us from using our NOLs to fully offset our taxable income for alternative minimum tax purposes. Further, the discrete period reporting of accrued interest and penalties on unrecognized tax positions as of December 31, 2012 remains a major contributor of the total tax expense.



Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay borrowings, fund investments, and for other general business purposes. Our primary sources of funds for liquidity consist of short-term borrowings (e.g., repurchase agreements), principal and interest payments on MBS and proceeds from sales of MBS. Other sources of liquidity include proceeds from the offering of common stock, preferred stock, debt securities or other securities registered pursuant to our effective shelf registration statement filed with the SEC. Liquidity, or ready access to funds, is essential to our business. Liquidity is of particular importance to our business and perceived liquidity issues may affect our counterparties' willingness to engage in transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects us or third parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time. If we cannot obtain funding from third parties or from our subsidiaries, our results of operations could be negatively impacted. Potential future sources of liquidity for us include existing cash balances, borrowing capacity through margin accounts and repurchase agreements and cash flows from operations, future issuances of common stock, preferred stock, debt securities or other securities registered pursuant to our shelf registration statement. Funding for agency-backed MBS through repurchase agreements continues to be available to us at rates we consider to be attractive from multiple counterparties, and we have observed increased availability for funding for private-label MBS through repurchase agreements. To gain additional flexibility in accessing capital markets for, among other things, the acquisition of MBS and other assets, the repayment of outstanding indebtedness, the pursuit of growth initiatives that may include acquisitions, working capital, and for liquidity needs, we filed a shelf registration statement on Form S-3 (File No. 333-171537) with the SEC on January 4, 2011 (the 2011 Shelf Registration). Pursuant to the 2011 Shelf Registration statement, on March 13, 2013, we completed a public offering of 3,450,000 shares of Class A common stock, including 450,000 shares purchased by the underwriters pursuant to an option granted by us to cover over-allotments, at a public offering price of $25.50 per share, for net proceeds of $87.0 million, after deducting underwriting discounts and commissions and expenses. During the year ended December 31, 2012, we completed two public offerings of 5,468,250 shares of Class A common stock, including 713,250 shares purchased by the underwriters pursuant to an option granted by us to cover over-allotments, for net proceeds of $129.3 million, after deducting underwriting discounts and commissions and expenses. 48 --------------------------------------------------------------------------------



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On May 1, 2013, we completed a public offering of $25.0 million aggregate principal amount of 6.625% Senior Notes due 2023 and received net proceeds of approximately $24.0 million after payment of underwriting commissions and expenses. The Senior Notes will mature on May 1, 2023, and may be redeemed in whole or in part at any time and from time to time at our option on or after May 1, 2016 at a redemption price equal to the principal amount redeemed plus accrued and unpaid interest. The interest payments on the Senior Notes are payable quarterly on February 1, May 1, August 1, and November 1 of each year. On May 24, 2013, we entered into separate equity distribution agreements (the Equity Distribution Agreements) with each of RBC Capital Markets, LLC, JMP Securities LLC, Ladenburg Thalmann & Co. Inc. and MLV & Co. LLC (Equity Sales Agents), pursuant to which we may offer and sell, from time to time, up to 1,750,000 shares of the Company's Class A common stock. Pursuant to the Equity Distribution Agreements, shares of our common stock may be offered and sold through the Equity Sales Agents in transactions that are deemed to be "at the market" offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from the Company, in privately negotiated transactions. As of December 31, 2013, we had not issued any shares of the Company's Class A common stock under the Equity Distribution Agreements. The 2011 Shelf Registration statement expired on January 20, 2014. On January 22, 2014 we filed a shelf registration statement on Form S-3 (File No. 333-193478) with the SEC (the 2014 Shelf Registration) that was declared effective by the SEC on February 5, 2014. The 2014 Shelf Registration statement will permit us to issue and publicly distribute various types of securities, including Class A common stock, preferred stock, debt securities, warrants and units, or any combination of such securities, from time to time, in one or more offerings, up to an aggregate amount of $750.0 million.



Sources of Funding

We believe that our existing cash balances, investments in private-label MBS, net investments in agency-backed MBS, cash flows from operations, borrowing capacity and other sources of liquidity will be sufficient to meet our cash requirements for at least the next 12 months. We have obtained, and believe we will be able to continue to obtain, short-term financing in amounts and at interest rates consistent with our financing objectives. We may, however, seek debt or equity financings, in public or private transactions, to provide capital for corporate purposes and/or strategic business opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities, including acquisitions and divestitures, as they arise. There can be no assurance that we will be able to generate sufficient funds from future operations, or raise sufficient debt or equity on acceptable terms, to take advantage of investment opportunities that become available. Should our needs ever exceed these sources of liquidity, we believe that most of our investments could be sold, in most circumstances, to provide cash. However, we may be required to sell our assets in such instances at depressed prices. As of December 31, 2013, our liabilities totaled $1.6 billion. In addition to other payables and accrued expenses, our indebtedness consisted of repurchase agreements and long-term debt. As of December 31, 2013, we had $40.0 million of total long-term debt. Our trust preferred securities with a principal amount of $15.0 million outstanding as of December 31, 2013 accrues and requires payment of interest quarterly at annual rates of three-month LIBOR plus 2.25% to 3.00% and matures between 2033 and 2035. Our Senior Notes with a principal amount of $25.0 million outstanding as of December 31, 2013 accrues and requires payment of interest quarterly at an annual rate of 6.625% and mature on May 1, 2023. As of December 31, 2013, our debt-to-equity leverage ratio was 2.9 to 1. We also have short-term financing facilities that are structured as repurchase agreements with various financial institutions to primarily fund our portfolio of agency-backed MBS. As of December 31, 2013, the weighted-average interest rate under these agreements was 0.45%. Our repurchase agreements include provisions contained in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association and may be amended and supplemented in accordance with industry standards for repurchase facilities. Our repurchase agreements include financial covenants, with which the failure to 49 --------------------------------------------------------------------------------



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comply would constitute an event of default under the applicable repurchase agreement. Similarly, each repurchase agreement includes events of insolvency and events of default on other indebtedness. As provided in the standard master repurchase agreement as typically amended, upon the occurrence of an event of default or termination event the applicable counterparty has the option to terminate all repurchase transactions under such counterparty's repurchase agreement and to demand immediate payment of any amount due from us to the counterparty. Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (i.e., a margin call), which may take the form of additional securities or cash. Margin calls on repurchase agreements collateralized by our MBS investments primarily result from events such as declines in the value of the underlying mortgage collateral caused by factors such as rising interest rates or prepayments. To date, we have not had any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged collateral. However, should we encounter increases in interest rates or prepayments, margin calls on our repurchase agreements could result in a material adverse change in our liquidity position. In the event that market conditions are such that we are unable to obtain financing for our investments in MBS in amounts and at interest rates consistent with our financing objectives, to the extent deemed appropriate, we may use cash to finance our investments or we may liquidate such investments. Accordingly, depending on market conditions, we may incur significant losses on any such sales of MBS. The following table provides information regarding our outstanding repurchase agreement borrowings as of the dates and periods indicated (dollars in thousands): [[Image Removed]] [[Image Removed]] [[Image Removed]] December 31, 2013 2012 Outstanding balance $ 1,547,630$ 1,497,191 Weighted-average rate 0.45 % 0.52 % Weighted-average term to maturity 13.2 days 14.5 days Maximum amount outstanding at any month-end $ 1,801,383$ 1,497,191 during the period Assets Our principal assets consist of MBS, cash and cash equivalents, receivables, deposits, long-term investments and deferred tax assets. As of December 31, 2013, liquid assets consisted primarily of cash and cash equivalents of $48.6 million and net investments in MBS of $370.2 million. Cash equivalents consist primarily of money market funds invested in debt obligations of the U.S. government. Our total assets increased from $2.1 billion at December 31, 2012 to $2.2 billion as of December 31, 2013. The increase in total assets reflects the deployment of capital raised from our public offerings during the year ended December 31, 2013 on a leveraged basis into our MBS portfolio. As of December 31, 2013, the total par and fair value of the MBS portfolio was $2.0 billion and $1.9 billion, respectively. As of December 31, 2013, the weighted average coupon of the portfolio was 3.90%.



Cash Flows

As of December 31, 2013, our cash and cash equivalents totaled $48.6 million representing a net increase in the balance of $12.8 million from $35.8 million as of December 31, 2012. Cash provided by operating activities of $61.4 million during 2013 was offset by net cash outflows of $166.2 million from investing activities and net cash inflows of $117.6 million from financing activities. Cash provided by operating activity was attributable primarily to net income.



Our investing activities during 2013 included proceeds from sales of, and receipt of principal payments from, MBS totaling $1.2 billion. These cash inflows were offset by $1.4 billion used to purchase MBS during 2013. Our financing activities during 2013 reflected net proceeds from repurchase agreement borrowings of $50.4 million and net proceeds from completed public offerings of $111.0 million offset by $43.9 million in dividends paid.

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As of December 31, 2012, our cash and cash equivalents totaled $35.8 million representing a net increase in the balance of $15.8 million from $20.0 million as of December 31, 2011. Cash provided by operating activities of $25.7 million during 2012 was offset by net cash outflows of $940.7 million from investing activities and net cash inflows of $930.8 million from financing activities. Cash provided by operating activity was attributable primarily to cash operating income and net changes in operating assets and liabilities. Our investing activities during 2012 included proceeds from sales of, and receipt of principal payments from, MBS totaling $476.2 million. These cash inflows were offset by $1.4 billion used to purchase MBS during 2012. Our financing activities during 2012 reflected net proceeds from repurchase agreement borrowings of $849.2 million and net proceeds from completed public offerings of Class A common stock of $129.2 million offset by $46.8 million in dividends paid. Dividends Pursuant to our variable dividend policy, our Board of Directors evaluates dividends on a quarterly basis and, in its sole discretion, approves the payment of dividends. Our dividend payments, if any, may vary significantly quarter to quarter. The Board of Directors approved and we declared and paid the following dividends for 2013: [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Quarter Ended Dividend Amount Declaration Date Record Date Pay Date December 31 $ 0.875 December 19 December 31 January 31, 2014 September 30 0.875 September 18 September 30 October 31 June 30 0.875 June 17 June 28 July 31 March 31 0.875 March 15 March 28 April 30



The Board of Directors approved and we declared and paid the following dividends for 2012:

[[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Quarter Ended Dividend Amount Declaration Date Record Date Pay Date December 31 $ 0.875 December 5 December 17 December 31 September 30 0.875 September 13 September 28 October 31 June 30 0.875 June 15 June 29 July 31 March 31 0.875 March 16 March 26 April 30



The Board of Directors approved and we declared and paid the following dividends for 2011:

[[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] Quarter Ended Dividend Amount Declaration Date Record Date Pay Date December 31 $ 0.875 December 21 December 31 January 31, 2012 September 30 0.875 September 19 September 30 October 31 June 30 0.875 June 23 July 5 July 29 March 31 0.750 March 24 April 4 April 29



Contractual Obligations

We have contractual obligations to make future payments in connection with borrowings and non-cancelable lease agreements and other contractual commitments. The following table sets forth these contractual obligations by fiscal year (in thousands):

[[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] [[Image Removed]] 2014 2015 2016 2017 2018 Thereafter Total Borrowings(1) $ - $ - $ - $ - $ - $ 40,000 $ 40,000 Minimum rental and other 256 15 446 458 471 980 2,626 contractual commitments(2) $ 256 $ 15 $ 446 $ 458 $ 471 $ 40,980 $ 42,626 [[Image Removed]]



(1) This table excludes interest payments to be made on our long-term debt

securities. Based on the weighted average interest rate of 3.00%,

approximately $113.6 thousand in accrued interest on the current outstanding

principal will be paid for the quarter ending March 31, 2014 on the $15.0

million of trust 51

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preferred debt. Interest on the trust preferred debt is based on the 3-month

LIBOR; therefore, actual coupon interest will likely differ from this

estimate. The trust preferred debt will mature beginning in October 2033

through July 2035. As of December 31, 2013, approximately $414.1 thousand in

accrued interest on the current outstanding principal will be paid for the

quarter ending March 31, 2014 on the $25.0 million of Senior Notes. The

Senior Notes have an annual interest rate of 6.625% and will mature on May 1,

2023. (2) Equipment and office rent expense for 2013, 2012 and 2011 was $242.9 thousand, $262.7 thousand and $173.3 thousand, respectively.



We also have short-term repurchase agreement liabilities of $1.5 billion as of December 31, 2013. See Note 4 to the financial statements for further information.

Off-Balance Sheet Arrangements and Other Commitments

From time to time in the ordinary course of our business, we may enter into contractual arrangements with third parties that include indemnification obligations of varying scope and terms. In addition, in the past, we have entered into indemnification agreements with certain of our current and former directors and officers under which we are generally required to indemnify them against liability incurred by them in connection with any action or proceeding to which they are or may be made a party by reason of their service in those or other capacities. Our charter and the Virginia Stock Corporation Act also generally require us to indemnify our directors and officers against any liability incurred by them in connection with any action or proceeding to which they are or may be made a party by reason of their service in those or other capacities, subject to certain exceptions. In the future we may be the subject of indemnification assertions under our charter, Virginia law or these indemnification agreements by our current or former directors and officers who are or may become party to any action or proceeding. We maintain directors' and officers' insurance policies that may limit our exposure and enable us to recover a portion of any amounts paid with respect to such obligations. However, it is not possible to determine the maximum potential amount of exposure under these indemnification obligations due to the varying terms of such obligations, the limited history of prior indemnification claims, the unique facts and circumstances involved in connection with each particular contractual arrangement and each potential future claim for indemnification and the contingency of any potential liabilities upon the occurrence of events that are not reasonably determinable. Such indemnification agreements may not be subject to maximum loss clauses and the maximum potential amount of future payments we could be required to make under these indemnification obligations could be significant. See "Item 1A - Risk Factors" in this Annual Report on Form 10-K. As of December 31, 2013 and 2012, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, as of December 31, 2013 and 2012, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities. See Note 9 to our consolidated financial statements under "Item 8 - Financial Statements and Supplementary Data."


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