News Column

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

February 14, 2014

The following discussion should be read in conjunction with our financial statements and accompanying notes included in Item 8 of this Annual Report on Form 10-K. 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"), U.S. Treasury Securities and U.S. Agency Debentures, although we had not invested in any CMOs as of December 31, 2013. We commenced operations in February 2006, and completed our initial public offering in June 2009. Our common stock, our 7.75% Series A Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A Preferred Stock"), and our 7.50% Series B Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series B Preferred Stock"), trade on the New York Stock Exchange under the symbols "CYS," "CYS PrA" and "CYS PrB," 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 net spread, or difference, 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 interest rates in a manner that will allow us to achieve attractive spreads on our portfolio. 25



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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, 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 rates;



• competition for investments in Agency RMBS;

• actions or inactions taken by the U.S. Government, including 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.

Changes in interest rates may significantly influence our net investment income and net asset value. 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 face value, changes in prepayment rates will impact our anticipated yield. Trends and Recent Market Impacts The volatility in the U.S. interest rate markets in 2011 and 2012 persisted into 2013 creating a challenging year for fixed income investors, especially those that utilize leverage in 2013. The strengthening U.S. economy prompted market participants to anticipate changes in policies of the Federal Reserve. Specifically, the markets began to anticipate tapering or the end of asset purchases by the Federal Reserve, and longer-term, moving the Target Federal Funds rate to a level closer to what the Federal Reserve deems neutral. Markets anticipated these policy changes by repricing longer-dated bonds to reflect the likely path of Federal Reserve policy over the next several years. These market movements combined to create an outsized interest rate move in the spring of 2013, which pushed Agency RMBS prices much lower. The volatility in the U.S. interest rate markets was impacted by the uncertainty around who would be nominated as the next Federal Reserve Chairman until it was resolved with the nomination of Janet Yellen by President Obama on October 9, 2013. Other factors such as the effects of the budget sequestration, the government shutdown in October 2013 and debates over the debt ceiling impacted interest rates and bond markets throughout the year. The real economy is testing whether economic growth can continue in a higher interest rate environment, and it is unclear whether U.S. gross domestic product and employment growth will moderate or accelerate. Given this uncertainty, we expect interest rate volatility to remain elevated. Importantly, the higher rate environment has created an 26



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improved investing environment which should allow us to generate an attractive dividend while operating at the low end of our leverage range, which should reduce volatility in net asset value. More detail is provided below. U.S. Federal Reserve In September 2012, the FOMC announced QE3, an open-ended program to purchase an additional $40 billion of Agency RMBS per month until the unemployment rate, among other economic indicators, showed signs of improvement. This program, when combined with the Federal Reserve's programs to extend its holdings' average maturity, and reinvest principal payments from its holdings of agency debt and Agency RMBS into Agency RMBS, was 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. The Federal Reserve provided further guidance to the market in December 2012, by stating 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 Federal Reserve also announced that it would continue to purchase longer-term Treasury securities into 2013 at a pace of about $45 billion per month and continue purchasing additional Agency RMBS by about $40 billion per month. This was the backdrop to 2013, and as economic indicators showed signs of improvement, the market reacted to both actual and implied messages from the FOMC as to when the Federal Reserve would begin tapering its asset purchases. The first quarter of 2013 U.S. gross domestic product ("GDP") was only 1.1%. However, during the second quarter of 2013, the U.S. economy began to show signs of increased growth, trending toward 2.5% GDP, and by May 2013, there was talk of the Federal Reserve beginning to slow down the pace of asset purchases that had been established in September 2012 and reconfirmed in December 2012. As 2013 progressed, GDP maintained a steady increase, and, while unemployment rates continued to fall, these rates were clouded to some extent by a decrease in labor force participation. The following graph shows changes in GDP, Personal Consumption Expenditures Index ("PCE Index") and the unemployment rate for the period from December 31, 2010 to December 31, 2013. [[Image Removed]]



In the April 30-May 1, 2013 FOMC meeting, most of the Committee members agreed to continue purchases of Agency RMBS at a pace of $40 billion per month and purchases of longer-term Treasury securities at a pace of $45 billion per

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month. The FOMC retained its forward guidance about the federal funds rate, including thresholds on the unemployment and inflation rates. On May 22, 2013, the date on which the May FOMC meeting minutes were released, Chairman Bernanke, responding to a question from the U.S. Congress Joint Economic Committee, stated "If we see continued improvement and we have confidence that it will be sustained then we could in the next few meetings take a step down in our pace of purchases." The market reacted to this comment. Following this statement, the 10 Year Treasury rate rose above 2%, the Primary Mortgage Rate rose to 3.73% and the price of bonds and stocks decreased significantly. The Primary Mortgage Rate includes only 30-Year fixed mortgage products with and without points and is an overnight national average index. In the June 18-19, 2013 FOMC meeting, the FOMC again agreed to continue purchases of Agency RMBS and longer-term Treasury securities at the same combined pace of $85 billion per month, and retained its forward guidance about the federal funds rate, including thresholds on the unemployment and inflation rates. On June 19, 2013, at the FOMC Press Conference, Chairman Bernanke, responding to a journalist's question referring to a hypothetically optimistic economy, stated "In that case, we would expect probably to slow or moderate purchases some time later this year, and through the middle part of early next year, and ending, in that scenario, somewhere in the middle of the year." Following Chairman Bernanke's remarks, the rate on the 10 Year Treasury rose to 2.35% and the Primary Mortgage Rate rose to 4.24%. At the July 30-31, 2013 FOMC meeting, the Committee, despite some improvement in the labor market and modest economic expansion, decided to continue asset purchases, at which point the market started to build in the expectation of a September 2013 taper. However, at the September 17-18, 2013 FOMC meeting, against many market participants' expectations, the Committee decided to hold back on tapering, causing a rapid move downward in interest rates with the 10 Year Treasury rate ending the third quarter at 2.61%. The Federal Reserve continued to maintain its position that the timing and scope of tapering is dependent upon improving economic indicators. The economic projections of Federal Reserve Board Members included in the minutes of the Federal Reserve's September 2013 meeting show inflation below the Federal Reserve's target inflation rate of 2% through 2016. In addition, the projections showed estimates for real GDP growth at 2.2% to 3.3% for 2014. It is important to note that over the past several years, actual employment growth has been consistently below the Federal Reserve's projections. The market was left to speculate whether the FOMC would instigate the taper in December 2013 or later on in 2014, though by mid-December 2013 the 10 Year Treasury rate had already increased to a two-year high of over 2.8% suggesting an earlier tapering was built into the market. At the December 18, 2013 FOMC meeting, the Committee indicated that it saw improvement in economic activity and labor market conditions. As a result, the FOMC announced that, beginning in January 2014, it would reduce its monthly purchases of Agency RMBS from $40 billion to $35 billion and U.S. Treasury securities from $45 billion to $40 billion. The FOMC further stated that it would continue reinvesting principal payments from its holdings of these securities in Agency RMBS and rolling over maturing U.S. Treasury securities at auction. On January 29, 2014 the FOMC announced additional $5 billion reductions to its monthly purchases of both Agency RMBS and Treasury bonds to take effect in February 2014. The FOMC expects even the lower level of purchases to maintain downward pressure on longer-term interest rates, support mortgage markets and make broader financial conditions more accommodative, which it believes should promote economic recovery and control inflation. The market reacted with some relief that the tapering had finally begun and the 10 Year Treasury rate moved above 2.90% closing on December 31, 2013 at 3.03%. The Primary Mortgage Rate ended the year at 4.54%. 28



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This considerable volatility is illustrated by the graph below:

[[Image Removed]] U.S. Employment For the twelve months of 2013, the U.S. economy produced an average of 193,500 jobs a month. In that same period, the U.S. unemployment rate fell from 7.9% in December 2012 to 6.7 % in December 2013. However, the participation rate also decreased from 63.6% in December 2012 to 62.8% in December 2013, the lowest rate since 1977, reflecting disillusion among many of the long-term unemployed who have removed themselves from the workforce statistics. While these employment figures are positive compared to the 2012 figures, we believe there are still many structural impediments to the creation of significant numbers of jobs and uncertainty in the marketplace surrounding the longer-term pace of job creation. Fiscal and tax policy continues to be a concern for the U.S. economy and will likely remain a primary focus of policy makers. In addition, the effects of the government shutdown and rising interest rates on the consumer and employment statistics will likely take several quarters to be reflected in the economic data. U.S. Housing Building on momentum in 2012, the U.S. housing market has continued to improve with existing home sales increasing and select regions are showing an increase in average home prices. According to the FHFA U.S. house price index, U.S. home prices rose 7.0% from December 2012 to October 2013. In addition to home prices, housing starts have improved. U.S. building permits hit their highest level since 2008 in October 2013 at 1,039,000, with an average of 962,000 per month since December 2012. To put this figure in perspective, the December 2002 annual rate was 1,896,000. Therefore, this housing recovery can be described as improving moderately, but at a slower pace than prior recoveries. Similar to U.S. employment, it is likely that the higher interest rates will slow the housing recovery. The following trends and recent market impacts may also affect our business: Interest Rates 29



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As described above, the actions by the Federal Reserve have had a significant impact on mortgage rates in 2013 and created a significant steepening in the yield curve and considerable interest rate volatility. While short term rates have been relatively unchanged, the market's reaction to the possibility of the U.S. Federal Reserve tapering large scale asset purchases pushed the long end of the yield curve up, bringing the 10 Year Treasury rate up 127 basis points from 1.76% at December 31, 2012 to 3.03% at December 31, 2013. During the same period the yields on par-priced Fannie Mae Agency RMBS backed by 30 year and 15 year fixed rate mortgage loans, increased 138 and 100 basis points respectively, bringing the yields to 3.61% and 2.68%, respectively, at December 31, 2013. This was significantly different from the situation during the year ended December 31, 2012, when the 10 Year U.S. Treasury rate decreased 12 basis points from 1.88% at December 31, 2011 to 1.76% at December 31, 2012. In addition, the yields on par-priced Fannie Mae Agency RMBS backed by 30 year and 15 year fixed rate mortgage loans decreased 65 and 42 basis points, respectively, bringing the yields to 2.23% and 1.68%, respectively, at December 31, 2012. [[Image Removed]] The increase in yields on Agency RMBS in 2013 was generally correlated with the increase in yield on the 10 Year Treasury. However, the increase in demand, primarily from the U.S. Federal Reserve, has added to the yield movement on Agency RMBS. An example of how demand has impacted the yield movement on Agency RMBS is to look at the spread between the yield on Fannie Mae Agency RMBS backed by 15 year 3.0% and 30 year 3.5% and the five year interest rate swap rate. 30



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The following graph compares market levels for three benchmark securities or rates, the yield on 10 year U.S. Treasury Notes, the five year interest rate swap rate and the yield for a 30 year 3.5% Fannie Mae RMBS. [[Image Removed]]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 0.35% and 0.45% for 30-90 day repurchase agreements at December 31, 2013. Date 30-Day LIBOR 3-Month LIBOR Federal Funds Target Rate December 31, 2013 0.168 % 0.246 % 0.25 % September 30, 2013 0.179 % 0.249 % 0.25 % June 30, 2013 0.195 % 0.273 % 0.25 % March 31, 2013 0.204 % 0.283 % 0.25 % December 31, 2012 0.209 % 0.306 % 0.25 % 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 % Investing and Reinvestment Environment In 2012, the Company benefited from lower interest rates supported by the U.S. Federal Reserve and Agency RMBS prices rose to all-time highs, however, spreads were compressed. In contrast, 2013 was a much more challenging year. In particular, in the second quarter of 2013, the prices of Agency RMBS detached from Treasury securities and swaps, causing a decline in the Company's net assets. A portion of this decline was reversed in the third quarter of 2013 as Agency RMBS prices increased resulting in a stabilization of the Company's net assets. In the fourth quarter of 2013, rising interest rates again put 32



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pressure on Agency RMBS prices causing the Company's net assets to decline. The movement in Agency RMBS prices is correlated with the volatility in interest rates as illustrated by the movement in prices of two securities commonly held in our portfolio. [[Image Removed]] Reinvestment Environment During 2013, the yield curve steepened, which created a more favorable reinvesting environment for the Company. The table below shows potential Agency RMBS investments and their respective net interest margins as of January 30, 2014: 30 Yr. 4.0% 15 Yr. 3% Asset Yield 3.35 % 2.35 % Financing Rate 0.39 % 0.39 % Hedge Cost (1) 0.99 % 0.52 % Net interest margin 1.97 % 1.44 % __________________ (1) Assumed 5 Year and 4 Year Swap Hedge Ratio, respectively 70



% 50 %

During the three months ended December 31, 2013, the average yield on the Company's purchases of Agency RMBS was 2.62%. Prepayment Rates As illustrated by the graph below, prepayment rates dropped to historic lows as interest rates increased in 2013. 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: 33



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Table of Contents [[Image Removed]] Source: eMBS Government Activity GSE Reform GSE reform remained a prominent issue throughout 2013, and we expect debate and discussion on the topic to continue throughout 2014. The FHFA and both houses of Congress are each working on separate measures aimed at dramatically restructuring the operations of Fannie Mae and Freddie Mac. It is unclear which, if any, of these measures will be enacted, and, if any are enacted, what the effects of would be. On October 4, 2012, the FHFA released a 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 common securitization platform 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. 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 34



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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. 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 (the "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: (i) the establishment of the Federal Mortgage Insurance Corporation (the "FMIC"); (ii) the creation of a Mortgage Insurance Fund (the "Fund"); and (iii) the wind-down of Fannie Mae and Freddie Mac. The FMIC would be a government guarantor modeled after the 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 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. 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 July 11, 2013, members of the U.S. House of Representatives introduced the Protecting American Taxpayers and Homeowners Act ("PATH"), a broad financing reform bill that serves as a counterpart to the Corker-Warner Bill. PATH would also revoke the charters of Fannie Mae and Freddie Mac and remove barriers to private investment. However, PATH would maintain the FHFA and give it oversight over a new non-government, not-for-profit National Mortgage Market Utility whose mission would be to develop best practices standards for the private origination, servicing, pooling and securitizing of mortgages and operate a publicly accessible securitization outlet to match loan originators with investors. Additional provisions of PATH include the reduction in size and scope of the FHA, narrowing its mission to first-time borrowers and low- and moderate- income borrowers except in periods of significant credit contraction. Dodd-Frank Act On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act is extensive, complicated and comprehensive legislation that impacts practically all aspects of banking and 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 35



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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 (which

has included requiring some over-the-counter derivatives to be cleared on

an exchange) and non-admitted property and casualty insurers and reinsurers; • implementing regulation of hedge fund and private equity advisers by requiring such advisers to register with the SEC;



• providing for the implementation of corporate governance provisions for

all public companies concerning proxy access and executive compensation;

and

• reforming regulation of credit rating agencies.

The Dodd-Frank Act established the Office of Financial Research within the Treasury Department to improve the quality of financial data available to policymakers and to facilitate more robust and sophisticated analysis of the financial system. This analysis may also include the scrutiny of mortgage REITs for potential systematic risk.



Qualified Mortgages

The Dodd-Frank Act requires that lenders make a good faith effort to ensure consumers have an ability to repay new mortgage loans based on verified and documented information. To accomplish this, the Dodd-Frank Act created the Consumer Financial Protection Bureau ("CFPB"), which was assigned the responsibility of defining Qualified Mortgage ("QM"). The key factor for lenders and originators is that loans which meet the QM standard give lenders "safe harbor" against future claims that the loans violated "ability to repay" requirements. In January 2013, the CFPB published the definition of a QM. An important part of the QM definition is the cap on how much income can go toward debt: along with the other tests, mortgages made to people who have debt-to-income ratios less than or equal to 43 percent will be considered QM. This requirement helps ensure consumers are borrowing only what they can likely afford and it creates one level of protection for lenders. Before the crisis, many consumers took on mortgages they could not afford based on their incomes and the QM rules are intended to protect consumers going forward. For a temporary, transitional period, loans that do not have a 43 percent debt-to-income ratio but meet government affordability or other standards, such as eligibility for purchase by Fannie Mae or Freddie Mac, will be considered QMs. Agency RMBS will continue to be a large portion of the overall mortgage market, and we believe that, as a result of this rule-making, it is unlikely that lenders will be willing to make loans without the safe harbor protections of QM. Lenders will be more deliberate and the resulting mortgages will be more consistent and will result in more predictable prepayments. We do not expect this to impact the current supply of Agency RMBS. 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 their impact. 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. For a discussion of additional risks relating to our business see "Risk Factors" beginning on page 6 of this Annual Report on Form 10-K. Financial Condition As of December 31, 2013 and 2012, the Agency RMBS in our portfolio were purchased at a net premium to their face value due to the average coupon interest rates on these investments being higher than the prevailing market rates at the time of purchase. As of December 31, 2013 and 2012, we had approximately $351.5 million and $879.6 million, respectively, of unamortized premium included in the cost basis of our investments. As of December 31, 2013 and 2012, our Agency RMBS portfolio consisted of the following assets: 36



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Table of Contents December 31, 2013 Face Value Fair Value Weighted Average Asset Type (in thousands) Cost/Face



Fair Value/Face MTR(1) Coupon CPR(2)

15 Year Fixed Rate $ 6,337,536$ 6,510,958$ 102.58 $ 102.74 N/A 3.13 % 5.3 % 20 Year Fixed Rate 84,730 90,795 103.07 107.16 N/A 4.50 % 16.0 % 30 Year Fixed Rate 5,145,151 5,214,548 102.15 101.35 N/A 3.78 % 3.6 % Hybrid ARMs 2,007,380 2,042,547 103.57 101.75 66.1 2.56 % 12.6 % Total/Weighted Average $ 13,574,797$ 13,858,848$ 102.57 $ 102.09 3.30 % 6.0 % December 31, 2012 10 Year Fixed Rate $ 207,091$ 219,747$ 103.60 $ 106.11 N/A 3.50 % 19.4 % 15 Year Fixed Rate 11,092,374 11,717,136 104.32 105.63 N/A 3.05 % 16.1 % 20 Year Fixed Rate 1,087,835 1,148,932 104.96 105.62 N/A 3.17 % 10.1 % 30 Year Fixed Rate 3,571,692 3,817,488 105.78 106.88 N/A 3.59 % 8.9 % Hybrid ARMs 3,722,510 3,900,840 103.54 104.79 74.3 2.71 % 19.1 % Total/Weighted Average $ 19,681,502$ 20,804,143$ 104.47 $ 105.70 3.10 % 15.8 %



__________________

(1) MTR is the weighted average 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 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.

The CPR of our Agency RMBS portfolio was approximately 5.9% for the month of January 2014. 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 December 31, 2013 and 2012, the average final contractual maturity of our mortgage portfolio is in year 2036 and 2033, respectively. The average expected life of our Agency RMBS reflects the estimated average period of time the securities in our portfolio will remain outstanding. The average expected life of our Agency RMBS portfolio does 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 and cap contracts. 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 37



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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 are 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 rate 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. Given the rise in interest rates during 2013, the duration of our Agency RMBS portfolio increased. In response to this increased duration, we increased the hedge percentage of our portfolio from 52.3% on December 31, 2012 to 73.7% on December 31, 2013. Below is a summary of our interest rate swaps and caps as of December 31, 2013 and 2012: December 31, 2013



Weighted Average

Number of Contracts Notional (000's) Rate (1) Maturity Fair Value (000's) Interest Rate Swaps 14 $ 6,300,000 1.173 % July 2017 $ 31,546 Interest Rate Caps 10 3,900,000 1.404 % May 2019 234,703 December 31, 2012 Interest Rate Swaps 21 $ 7,490,000 1.270 % August 2015 $ (97,395 ) Interest Rate Caps 10 3,400,000 1.622 % July 2019 122,989 ___________ (1) For interest rate swaps, rate represents the fixed pay rate. For interest rate caps, rate represents the cap rate. 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 December 31, 2013, we had approximately $11,207.0 million of liabilities pursuant to repurchase agreements with 24 counterparties that had weighted average interest rates of approximately 0.41%, and a weighted average maturity of 39.9 days. In addition, as of December 31, 2013, we had approximately $1,556.8 million in payable for securities purchased, a portion of which will be financed through repurchase agreements. At December 31, 2012, we had approximately $13,981.3 million of liabilities pursuant to repurchase agreements with 23 counterparties that had weighted average interest rates of approximately 0.48%, and a weighted average maturity of 19.6 days. In addition, as of December 31, 2012 we had approximately $4,515.5 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 December 31, 2013 and 2012 (in thousands). December 31, 2013 Settle Date Face Value Payable FHLMC - 30 Year 4.0% Fixed 1/13/2014 $ 75,000$ 77,244 FNMA - 30 Year 4.0% Fixed 1/13/2014 700,000 726,965 FNMA - 30 Year 3.0% Fixed 1/16/2014 732,000 752,612 $ 1,507,000$ 1,556,821 38



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FNMA - 20 Year 3.0% Fixed 1/14/2013$ 300,000$ 316,122 FNMA - 30 Year 3.5% Fixed 1/14/2013 1,550,000 1,646,880 FNMA - 15 Year 2.5% Fixed 1/17/2013 950,000 993,307 FNMA - 15 Year 3.5% Fixed 1/17/2013 38,000 40,363 FNMA - 15 Year 4.5% Fixed 1/17/2013 16,000 17,232 FNMA - 30 Year 2.43% Hybrid ARM 1/24/2013 25,000 26,234 FNMA - 30 Year 2.60% Hybrid ARM 1/25/2013 50,000 52,259 FNMA - 30 Year 2.15% Hybrid ARM 1/29/2013 100,000 103,542 FNMA - 30 Year 2.57% Hybrid ARM 1/29/2013 82,000 85,618 FNMA - 30 Year 3.5% Fixed 2/12/2013 200,000 212,651 FNMA - 15 Year 2.5% Fixed 2/14/2013 950,000 990,186 FNMA - 30 Year 2.17% Hybrid ARM 2/25/2013 30,000 31,107

$ 4,291,000$ 4,515,501 Results of Operations Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012 Net Income (Loss) Available to Common Shares. Net income available to common shares decreased $862.0 million to net loss of $491.6 million for the year ended December 31, 2013, compared to net income of $370.4 million for the year ended December 31, 2012. The major components of this decrease are detailed below. Investment Income. Investment income, which primarily consists of interest income on Agency RMBS, increased by $38.7 million to $332.0 million for the year ended December 31, 2013, as compared to $293.3 million for the year ended December 31, 2012. Interest income from Agency RMBS increased by $41.5 million for the year ended December 31, 2013 due to the increased size of our average settled Agency RMBS portfolio and change in average yield on Agency RMBS as shown below (in thousands): Change in Size Change in Yield Change in Size & Yield Change in Change in Change



in

average settled $ 2,345,312 average yield (0.09 )% average settled $ 2,345,312 2012 average 2012 average Change in yield 2.33 % settled 12,391,404 average yield (0.09 )% Change $ 54,691 Change $ (11,117 ) Change

$ (2,104 ) Total change $ 41,470 Interest Expense. Interest expense increased $8.7 million to $52.8 million for the year ended December 31, 2013, as compared to $44.1 million for the year ended December 31, 2012. The impact of the change in interest expense from the increase in our average repurchase agreements outstanding and change in average rate on repurchase agreements is shown below (in thousands): Change in Size Change in Rate Change in Size & Rate Change in average Change in Change in average outstanding $ 2,014,241 average rate - % outstanding $ 2,014,241 2012 average Change in average 2012 average rate 0.41 % outstanding 10,822,005 rate - % Change $ 8,211 Change $ 367 Change $ 68 Total change $ 8,646 Operating Expenses. For the year ended December 31, 2013, operating expenses increased by $0.5 million to $21.0 million, compared to $20.5 million for the year ended December 31, 2012. Operating expenses as a percentage of net assets decreased during the year ended December 31, 2013 to 0.98% compared to 1.05% during the year ended December 31, 2012 due to an increase in the average net assets. Our average net assets were $2,145.4 million and $1,961.3 million during the year ended December 31, 2013 and 2012, respectively. Net Gain (Loss) From Investments. Net gain from investments decreased by $1,136.5 million to a net loss of $909.6 million for the year ended December 31, 2013, compared to a net gain of $226.9 million for the year ended December 31, 2012. The net loss for the year ended December 31, 2013 was caused by the rise in interest rates, which increased the yield on our 39



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asset portfolio, but also caused prices of our Agency RMBS to decline resulting in a decrease in our net asset value. During the year ended December 31, 2013 the price of Agency RMBS backed by 30 year 3.5% mortgages declined $7.25 to $99.36, and during the year ended December 31, 2012 they increased $3.75 to $106.61. Additionally, during the year ended December 31, 2013, our average Agency RMBS portfolio was significantly larger at $14,736.7 million compared to $12,391.4 million during the year ended December 31, 2012. Net Gain (Loss) from Swap and Cap Contracts. For the year ended December 31, 2013, we had a net gain from swap and cap contracts of $175.6 million, an increase of $258.4 million compared to a net loss of $82.8 million for the year ended December 31, 2012. The increase in net gain on swap and cap contracts was primarily due to the increase in swap rates combined with the increase in the size of our interest rate swap and cap portfolio. During the year ended December 31, 2013 and 2012, our average interest rate swap and cap notional amount was $11,866.2 million and $7,901.5 million, respectively. During the year ended December 31, 2013 and 2012, five year swap rates increased 92 basis points and decreased 36 basis points, respectively. Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011 Net Income Available to Common Shares. Net income available to common shares increased $78.5 million to $370.4 million for the year ended December 31, 2012, compared to net income of $291.9 million for the year ended December 31, 2011. The major components of this increase are detailed below. Investment Income. Investment income increased by $60.4 million to $293.3 million for the year ended December 31, 2012, as compared to $232.9 million for the year ended December 31, 2011. Interest income from Agency RMBS increased by $60.2 million for the year ended December 31, 2012 due to the increased size of our average settled Agency RMBS portfolio and change in average yield on Agency RMBS as shown below (in thousands): Change in Size Change in Yield Change in Size & Yield Change in Change in Change



in

average settled $ 5,038,813 average yield (0.78 )% average settled $ 5,038,813 2011 average 2011 average Change in yield 3.11 % settled 7,352,591 average yield (0.78 )% Change $ 156,777 Change $ (57,310 ) Change

$ (39,275 ) Total change $ 60,192 Interest Expense. Interest expense increased $25.3 million to $44.1 million for the year ended December 31, 2012, as compared to $18.8 million for the year ended December 31, 2011. The impact of the change in interest expense from the increase in our average repurchase agreements outstanding and change in average rate on repurchase agreements is shown below (in thousands): Change in Size Change in Rate Change in Size & Rate Change in average Change in Change in average outstanding $ 4,302,733 average rate 0.12 % outstanding $ 4,302,733 2011 average Change in average 2011 average rate 0.29 % outstanding 6,519,272 rate 0.12 % Change $ 12,401 Change $ 7,787 Change $ 5,140 Total change $ 25,328 Operating Expenses. For the year ended December 31, 2012, operating expenses decreased by $2.7 million to $20.5 million, compared to $23.2 million for the year ended December 31, 2011. The decrease in expenses was primarily the result of non-recurring expenses of $4.9 million incurred in 2011 relating to the accelerated vesting of shares of restricted common stock and other expenses associated with the Internalization. Overall operating expenses as a percentage of net assets decreased during the year ended December 31, 2012 to 1.05% compared to 2.34% during the year ended December 31, 2011. Our average net assets were $1,961.3 million and $989.0 million during the year ended December 31, 2012 and 2011, respectively. Net Gain (Loss) From Investments. Net gain from investments decreased by $34.5 million to $226.9 million for the year ended December 31, 2012, compared to $261.4 million for the year ended December 31, 2011. In both years ended December 31, 2012 and 2011, prices of Agency RMBS rose. However, during the year ended December 31, 2012, the size of our Agency RMBS portfolio was significantly larger at an average of $12,391.4 million compared to $7,352.6 million during the year ended December 31, 2011. Net Gain (Loss) from Swap and Cap Contracts. Net loss from swap and cap contracts decreased by $77.6 million to a loss of $82.8 million for the year ended December 31, 2012, compared to a loss of $160.4 million for the year ended December 31, 2011. The decrease in net loss on swap and cap contracts was primarily due to the decrease in swap rates combined with the increase in the size of our interest rate swap and cap portfolio. During the year ended December 31, 2012 and 2011, our average 40



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interest rate swap and cap notional amount was $7,901.5 million and $5,151.5 million, respectively. During the year ended December 31, 2012 and 2011, three year swap rates decreased by 32 and 46 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 December 31, 2013 and 2012 (dollars in thousands). December 31, 2013 Within One Year One to Three Years Three to Five Years Total Repurchase agreements $ 11,206,950 $ - $ - $ 11,206,950 Interest expense on repurchase agreements, based on rates at December 31, 2013 12,202 - - 12,202 Long term operating lease obligation 293 393 - 686 Total $ 11,219,445 $ 393 $ - $ 11,219,838 December 31, 2012 Within One Year One to Three Years Three to Five Years Total Repurchase agreements $ 13,981,307 $ - $ - $ 13,981,307 Interest expense on repurchase agreements, based on rates at December 31, 2012 15,173 - - 15,173 Long term operating lease obligation 320 162 - 482 Total $ 13,996,800 $ 162 $ - $ 13,996,962 In addition, as of December 31, 2013 and 2012, we had a $1,556.8 million and $4,515.5 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 December 31, 2013 and 2012 is included in the "Financial Condition-Liabilities" section. 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. Effective June 2013, we began clearing interest rate swaps on exchanges, such as the Chicago Mercantile Exchange. For the $1.5 billion of interest rate swaps cleared on the exchanges as of December 31, 2013, we will no longer face the original trade counterparty, but will instead face the exchange. We expect this will reduce the risk of counterparty default for us. However, we will continue to have credit exposure to banks and broker dealers on our interest rate caps and swaps that are not cleared on an exchange. At December 31, 2013 and 2012, we had the following interest rate swap and cap contracts not cleared on an exchange (dollars in thousands): As of December 31, 2013 Weighted Average Maturity in Counterparty Total Notional Fair Value Amount At Risk (1) Years Barclays Bank plc $ 1,000,000$ 53,816 $ (1,319 ) 5.4 BNP Paribas 250,000 3,755 1,310 3.7 Credit Suisse International 1,550,000 14,453 13,523 3.8 Deutsche Bank 500,000 7,407 5,057 3.7 Goldman Sachs 500,000 (10,255 ) 8,602 1.1 ING Capital Markets, LLC 300,000 16,540 (161 ) 5.5 Morgan Stanley Capital Markets 750,000 3,881 4,306 3.6



Nomura Global Financial Products, Inc. 300,000 (9,526 )

9,580 2.4 The Royal Bank of Scotland plc 2,200,000 98,655 522 4.6 The Bank of Nova Scotia 750,000 45,126 1,143 5.4 UBS AG 300,000 16,970 50 5.5 Wells Fargo Bank, N.A. 300,000 14,679 (559 ) 5.4 Total $ 8,700,000$ 255,501 $ 42,054 41



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As of December 31, 2012

Weighted Average Amount At Risk Maturity in Counterparty Total Notional Fair Value (1) Years BNP Paribas $ 250,000$ 26$ 2,159 4.7 Credit Suisse International 2,050,000 27,922 13,190 6.0 Deutsche Bank 1,340,000 (10,733 ) 16,369 2.6 Goldman Sachs 1,800,000 (34,105 ) 20,416 1.5 ING Capital Markets, LLC 300,000 8,685 585 6.5 Morgan Stanley Capital Markets 1,250,000 29,135 16,474 6.6



Nomura Global Financial Products, Inc. 550,000 (19,629 )

6,336 2.6 The Bank of Nova Scotia 250,000 33 1,627 4.7 The Royal Bank of Scotland plc 2,500,000 7,543 9,457 2.4 UBS AG 300,000 9,165 925 6.5 Wells Fargo Bank, N.A. 300,000 7,552 1,449 6.4 Total $ 10,890,000$ 25,594$ 88,987 __________________



(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 unknown. 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 December 31, 2013 and 2012. Off-Balance Sheet Arrangements 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, 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 had any intent to provide funding to any such entities. Liquidity and Capital Resources As of December 31, 2013 and 2012, we had approximately $1,115.8 million and $1,519.3 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 always been able 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. Our primary sources of funds are borrowings under repurchase arrangements and monthly principal repayments and interest payments on our investments. Other sources of funds may include proceeds from debt and equity offerings and asset sales. As of December 31, 2013 and 2012, we had repurchase agreements totaling $11,207.0 million and $13,981.3 million, respectively, with a weighted average borrowing rate of 0.41% and 0.48%, respectively. In addition, during the year ended December 31, 2013 and 2012, we received $2,427.1 million and $2,889.8 million of principal repayments and $340.3 million and $274.6 million of interest payments, respectively. We held cash and cash equivalents of $5.0 million and $13.9 million at December 31, 2013 and 2012, respectively. During the year ended December 31, 2013 and 2012, our operations provided net cash of $2,924.0 million and used net cash of $7,048.9 million, respectively. During the year ended December 31, 2013 and 2012, we had net sales of securities (net of purchases, sales and principal repayments) of $5,970.9 million and net purchases of $11,280.4 million, respectively. The change in net purchases and sales of securities was the result of selling investments to manage our leverage ratio in an environment where prices of Agency RMBS were declining and due to our decreasing net assets as a result of share repurchases. Through our dividend reinvestment and direct stock purchase plan (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. The Company did not issue any shares under the DSPP during the year ended December 31, 2013. For the year ended 42



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December 31, 2012, we issued 5.3 million shares under the DSPP raising approximately $74.0 million of net proceeds. As of December 31, 2013 and 2012, there were approximately 4.1 million shares available for issuance under the DSPP. On June 7, 2011 we established an Equity Placement Program (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 privately negotiated transactions with JMP Securities LLC acting as sales agent. The Company did not issue any shares under the EPP during the year ended December 31, 2013. For the year ended December 31, 2012, the Company issued 11.9 million shares under the EPP raising approximately $164.3 million. As of December 31, 2013 and 2012, there were approximately 3.1 million shares of common stock available for issuance under the EPP. On November 15, 2012, we announced that our board of directors authorized the repurchase of shares of our common stock having an aggregate value of up to $250 million. We intend to repurchase shares only when the purchase price is less than our estimate of our current net asset value per share of our common stock. For the year ended December 31, 2013, we repurchased 13.6 million shares with a weighted average purchase price of $8.49, or approximately $115.7 million in the aggregate. As of December 31, 2013, we could repurchase up to $134.3 million of our common stock under this authorization by our board of directors. We did not make any repurchases during the year ended December 31, 2012. The following tables present certain information regarding our risk exposure on our repurchase agreements as of December 31, 2013 and 2012 (dollars in thousands): December 31, 2013 Weighted Total Average Outstanding % of Net Assets Maturity in Counterparty Borrowings % of Total At Risk (1) Days Bank of America Securities LLC $ 696,577 6.2 % 1.9 % 62 Bank of Nova Scotia 499,623 4.5 0.9 44 Barclays Capital, Inc. 590,527 5.3 1.4 56 BNP Paribas Securities Corp 742,922 6.6 2.1 50 Cantor Fitzgerald & Co. 66,576 0.6 0.3 13 Citigroup Global Markets, Inc. 668,826 6.0 2.0 41 Credit Suisse Securities (USA) LLC 382,998 3.4 1.4 44 Daiwa Securities America, Inc. 288,454 2.6 0.8 35 Goldman Sachs & Co. 493,688 4.4 1.4 32 Guggenheim Liquidity Services, LLC 372,338 3.3 1.1 56 Industrial and Commercial Bank of China Financial Services LLC 573,365 5.1 1.7 43 ING Financial Markets LLC 637,066 5.7 2.0 28 J.P. Morgan Securities LLC 387,915 3.5 1.2 38 KGS Alpha Capital Markets 113,346 1.0 0.4 55 LBBW Securities LLC 167,039 1.5 0.5 24 Mitsubishi UFJ Securities (USA), Inc. 576,941 5.1 1.6 50 Mizuho Securities USA, Inc. 527,009 4.7 1.5 13 Morgan Stanley & Co. Inc. 675,374 6.0 1.9 42 Nomura Securities International, Inc. 376,733 3.4 1.1 61 RBC Capital Markets, LLC 724,865 6.5 2.3 36 South Street Securities LLC 344,359 3.1 1.4 50 The Royal Bank of Scotland PLC 182,831 1.6 0.5 6 UBS Securities LLC 587,048 5.2 1.7 31 Wells Fargo Securities, LLC 530,530 4.7 1.5 6 $ 11,206,950 100.0 % 32.6 % _________ 43



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(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. 44



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Table of Contents December 31, 2012 Weighted Total Average Outstanding % of Net Assets Maturity in Counterparty Borrowings % of Total At Risk (1) Days Bank of America Securities LLC $ 1,143,279 8.2 % 2.4 % 16 Bank of Nova Scotia 660,889 4.7 1.1 12 Barclays Capital, Inc. 1,129,106 8.1 2.3 30 BNP Paribas Securities Corp 662,360 4.7 1.5 17 Citigroup Global Markets, Inc. 463,815 3.3 1.1 21 Credit Suisse Securities (USA) LLC 645,179 4.6 1.2 15 Daiwa Securities America, Inc. 305,954 2.2 0.7 22 Deutsche Bank Securities, Inc. 539,094 3.8 1.4 21 Goldman Sachs & Co. 1,058,174 7.6 2.4 17 Guggenheim Liquidity Services, LLC 281,225 2.0 0.6 22 Industrial and Commercial Bank of China Financial Services LLC 808,414 5.8 1.7 20 ING Financial Markets LLC 377,353 2.7 0.9 14 KGS Alpha Capital Markets 138,697 1.0 0.4 19 LBBW Securities LLC 140,953 1.0 0.3 28 Mitsubishi UFJ Securities (USA), Inc. 627,315 4.5 1.4 17 Mizuho Securities USA, Inc. 520,638 3.7 1.1 18 Morgan Stanley & Co. Inc. 634,179 4.5 1.6 17 Nomura Securities International, Inc. 623,556 4.5 1.5 21 RBC Capital Markets, LLC 791,610 5.7 1.8 17 South Street Securities LLC 375,289 2.7 1.1 18 The Royal Bank of Scotland PLC 167,604 1.2 0.4 9 UBS Securities LLC 936,333 6.7 2.3 38 Wells Fargo Securities, LLC 950,291 6.8 1.3 13 $ 13,981,307 100.0 % 30.5 % ____________________



(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. We also pledge collateral for our interest rate swaps and forward purchase transactions. We will receive margin calls on these transactions when the value of the swap or forward purchase transaction declines or when the value of any collateral 45



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pledged falls below a particular threshold level. All unrestricted cash and cash equivalents, plus any unpledged Agency RMBS or U.S. Treasury securities, are available to satisfy margin calls. 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 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 our stockholders. 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 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 years ended December 31, 2013 and 2012. Year Ended December 31, (In millions) 2013 2012 Outstanding at period end $ 11,207$ 13,981 Weighted average rate at period end 0.41 % 0.48 %



Average outstanding during period (1) $ 12,836$ 10,822 Weighted average rate during period

0.41 % 0.41 %



Largest month end balance during period $ 14,544$ 13,981 Leverage ratio (at period end) (2)

6.97:1 7.69:1



_______________

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

(2) Our leverage ratio was calculated by dividing (i) our repurchase

agreements balance plus payable for securities purchased minus receivable

for securities sold by (ii) net assets.

During the year ended December 31, 2013, our repurchase agreement balance decreased due to net sales of securities to manage our leverage ratio as the asset prices decreased in 2013. During the year ended December 31, 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 years ended December 31, 2013 and 2012, the weighted average rate on our repurchase agreements remained relatively stable. 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 46



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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. Critical Accounting Policies Our most critical accounting policies require us to make complex and subjective decisions and assessments that could affect our reported assets and liabilities, as well as our reported interest income and expenses. We believe that all of the decisions and assessments upon which our financial statements are based were reasonable at the time made based upon information available to us at that time. We rely on our management's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2 to the financial statements included elsewhere in this Annual Report on Form 10-K for a complete discussion of our significant accounting policies. We have identified our most critical accounting policies to be the following: Investment Company Accounting Our financial statements are prepared by management in accordance with GAAP. Although we conduct our operations so that we are not required to register as an investment company under the Investment Company Act, for financial reporting purposes we are considered an investment company and follow the accounting and reporting specified in ASC 946, Financial Services-Investment Companies. Accordingly, investments in securities are carried at fair value with changes in fair value recorded in the statement of operations. Effective January 1, 2014 we will be required to discontinue investment company accounting presentation. Valuation Agency RBMS and U.S. Treasury securities are generally valued on the basis of valuations provided by third party pricing services, as derived from such services' pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker/dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. Interest rate swaps and caps are generally valued using valuations provided by dealer quotations. Such dealer quotations are based on the present value of fixed and projected floating rate cash flows over the term of the swap contract. Future cash flows are discounted to their present value using swap rates provided by electronic data services or brokers. Recent Accounting Pronouncements In June 2013, the FASB issued ASU 2013-08, Financial Services-Investment Companies (Topic 946). This update modifies the guidance for Topic 946 for determining whether an entity is an investment company for GAAP purposes. Because the Company adopted Statement of Position 07-1 prior to its deferral, this update requires management to assess whether they continue to meet the definition of an investment company for GAAP purposes. The guidance is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013, with prospective application. Earlier application is prohibited. We have performed the assessment and determined that the Company does not meet the definition of an investment company in accordance with Topic 946. As a result, we will discontinue application of Topic 946 and shall account for our investments in conformity with applicable non-investment company U.S. GAAP, with prospective application on the effective date. We do not expect there will be any cumulative adjustments to retained earnings upon adoption as all investments will continue to be recorded at fair value on the balance sheet subsequent to adoption. Item 7A. Quantitative and Qualitative Disclosures about Market Risk As of December 31, 2013 and 2012, 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" 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 47



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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 contracts. Effect on Interest Income, Interest Expense and Net swap and cap interest income (expense). 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 cap contracts as of December 31, 2013 and 2012 described in detail under Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations and Commitments" in this Annual Report on Form 10-K. 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 those 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 contract 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. 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 48



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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 a variety of prepayment characteristics, and prepayment protections. 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 income exclusive of the effect on fair value 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 December 31, 2013 and 2012, assuming a static portfolio and that rates instantaneously fall 25, 50 and 75 basis points and rise 25, 50 and 75 basis points. 49



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Table of Contents December 31, 2013 Projected Change in the Projected Change in the Fair Value of Our Assets Fair Value of Our Assets (excluding hedging (including hedging Projected Change in Our Change in Interest Rates instruments)* instruments)* Net Income - 75 basis points 3.15 % 1.41 % 8.61 % (a) - 50 basis points 2.33 % 1.17 % 6.63 % (a) - 25 basis points 1.30 % 0.72 % 3.32 % (a) No Change - % - % - % + 25 basis points (1.35 )% (0.76 )% (8.29 )% + 50 basis points (2.72 )% (1.54 )% (16.58 )% + 75 basis points (4.11 )% (2.32 )% (24.87 )% December 31, 2012 Projected Change in the Projected Change in the Fair Value of Our Assets Fair Value of Our Assets (excluding hedging (including hedging Projected Change in Our Change in Interest Rates instruments)* instruments)* Net Income - 75 basis points 0.74 % (0.08 )% 13.32 % (a) - 50 basis points 0.80 % 0.24 % 10.66 % (a) - 25 basis points 0.56 % 0.24 % 5.33 % (a) No Change - % - % - % + 25 basis points (0.70 )% (0.37 )% (13.32 )% + 50 basis points (1.53 )% (0.86 )% (26.64 )% + 75 basis points (2.49 )% (1.45 )% (39.96 )% _____________



* Analytics provided by The Yield Book® Software (a) Given the low level of interest rates at December 31, 2013 and 2012, we

reduced 3 month LIBOR and our repurchase agreement rates by 10, 20 and 25

basis points for the down 25, 50 and 75 basis point net income scenarios,

respectively. All other interest rate sensitive instruments were calculated

in accordance with the table.

While the tables above reflect the estimated immediate impact of interest rate increases and decreases on a static portfolio, we rebalance our portfolio from time to time either to take advantage of or minimize the impact of changes in interest rates. 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. This process includes monitoring various stress test scenarios on our 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 based on current market conditions and various other factors, including the health of the financial institutions that lend to us under our repurchase agreements. 50



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We seek to mitigate our prepayment risk by investing in Agency RMBS with a variety of prepayment characteristics, and 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. 51



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Item 8. Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS



FINANCIAL STATEMENTS AS OF DECEMBER 31, 2013 AND 2012, AND FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011:

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 53 Statements of Assets and Liabilities 54 Schedules of Investments 55 Statements of Operations 62 Statements of Changes in Net Assets 63 Statements of Cash Flows 64 Notes to Financial Statements 65 52



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Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of CYS Investments, Inc.Waltham, MA We have audited the accompanying statements of assets and liabilities, including the schedules of investments, of CYS Investments, Inc. (formerly Cypress Sharpridge Investments, Inc., the "Company") as of December 31, 2013 and 2012, and the related statements of operations, changes in net assets, and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of CYS Investments, Inc. as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992), issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 14, 2014 expressed an unqualified opinion on the Company's internal control over financial reporting. /s/ DELOITTE & TOUCHE LLPFebruary 14, 2014Boston, Massachusetts 53



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Table of Contents CYS INVESTMENTS, INC. STATEMENTS OF ASSETS AND LIABILITIES December 31, (In thousands, except per share numbers) December 31, 2013



2012

ASSETS:

Investments in securities, at fair value (including pledged assets of $11,835,975 and $14,831,648, respectively)

$ 13,865,793$ 20,861,718 Derivative assets, at fair value 295,707



124,169

Cash and cash equivalents 4,992 13,882 Receivable for securities sold and principal repayments 429,233 10,343 Interest receivable 36,731 46,558 Other assets 608 826 Total assets 14,633,064 21,057,496 LIABILITIES: Repurchase agreements 11,206,950 13,981,307 Derivative liabilities, at fair value 29,458 98,575 Payable for securities purchased 1,556,821



4,515,501

Payable for cash received as collateral 37,938 28,910 Distribution payable 4,410 1,243



Accrued interest payable (including accrued interest on repurchase agreements of $7,204 and $11,717, respectively)

24,613 28,863 Accrued expenses and other liabilities 4,218 435 Total liabilities 12,864,408



18,654,834

Commitments and contingencies (note 11) - - NET ASSETS $ 1,768,656$ 2,402,662 Net assets consist of: Preferred Stock, $25.00 par value, 50,000 shares authorized: 7.75% Series A Cumulative Redeemable Preferred Stock, (3,000 and 3,000 shares issued and outstanding, respectively, liquidation preference of $25.00 per share or $75,000 and $75,000 in aggregate, respectively) $ 72,369 $ 72,369 7.50% Series B Cumulative Redeemable Preferred Stock, (8,000 and 0 shares issued and outstanding, respectively, liquidation preference of $25.00 per share or $200,000 and $0 in aggregate, respectively) 193,531 -



Common Stock, $0.01 par value, 500,000 shares authorized (161,650 and 174,924 shares issued and outstanding, respectively)

1,616 1,749 Additional paid in capital 2,046,530



2,237,512

Retained earnings (accumulated deficit) (545,390 ) 91,032 NET ASSETS $ 1,768,656$ 2,402,662 NET ASSET VALUE PER COMMON SHARE $ 9.24 $ 13.31 See notes to financial statements. 54



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS DECEMBER 31, 2013 INVESTMENTS IN SECURITIES - UNITED STATES OF AMERICA (In thousands) Face Amount Fair Value Fixed Income Securities - 784.0% (c) Mortgage Pass-Through Agency RMBS - 783.6% (c) Fannie Mae Pools - 679.5% (c) 2.14%, due 2/1/2043 (a)(b) $ 87,600$ 87,892 2.15%, due 10/1/2042 (a)(b) 40,103 40,356 2.18%, due 11/1/2042 (a)(b) 29,015 29,160 2.25%, due 10/1/2042 - 11/1/2042 (a)(b) 84,755 85,399 2.33%, due 11/1/2042 (a)(b) 63,251 64,029 2.36%, due 1/1/2043 (a)(b) 83,235 84,181 2.40%, due 9/1/2042 - 10/1/2042 (a)(b) 51,272 51,974 2.41%, due 11/1/2042 (a)(b) 62,378 63,235 2.42%, due 9/1/2042 (a)(b) 19,388 19,677 2.43%, due 7/1/2042 - 1/1/2043 (a)(b) 215,819 219,176 2.44%, due 6/1/2042 (a)(b) 45,301 46,050 2.50%, due 10/1/2042 (a)(b) 76,110 77,442 2.52%, due 10/1/2042 (a)(b) 45,306 46,099 2.57%, due 8/1/2042 (a)(b) 29,496 30,079 2.60%, due 4/1/2042 (a)(b) 31,018 31,707 2.70%, due 6/1/2042 (a)(b) 55,666 57,043 2.78%, due 4/1/2042 (a)(b) 133,381 137,323 2.80%, due 2/1/2042 - 4/1/2042 (a)(b) 84,553 87,096 2.81%, due 2/1/2042 (a)(b) 25,550 26,361 2.84%, due 12/1/2041 (a)(b) 43,963 45,398 3.00%, due 2/1/2027 - 2/1/2029 (a) 4,839,617 4,943,083 3.00%, due 12/1/2037 (a) 51,087 48,558 3.00%, due 10/1/2042 (a) 42,107 39,556 3.05%, due 9/1/2041 (a)(b) 28,001 28,987 3.24%, due 3/1/2041 (a)(b) 11,485 11,969 3.37%, due 5/1/2041 - 8/1/2041 (a)(b) 34,796



36,423

3.50%, due 12/1/2025 - 1/1/2029 (a) 948,463



992,515

3.50%, due 6/1/2042 - 9/1/2043 (a) 1,872,351



1,862,400

3.97%, due 9/1/2039 (a)(b) 7,363



7,842

4.00%, due 1/1/2026 - 4/1/2026 (a) 229,778



243,561

4.00%, due 7/1/2043 - 2/1/2044 (a) 2,106,542



2,169,411

4.50%, due 4/1/2030 - 11/1/2030 (a) 84,730 90,796 4.50%, due 11/1/2041 (a) 200,955 212,988 Total Fannie Mae Pools 11,764,435 12,017,766 Freddie Mac Pools - 90.2% (c) 2.20%, due 2/1/2043 (a)(b) 28,154 28,175 2.22%, due 12/1/2042 (a)(b) 42,719 42,887 2.30%, due 11/1/2042 (a)(b) 88,989 89,526 2.43%, due 6/1/2042 (a)(b) 34,581 35,224 2.44%, due 4/1/2043 (a)(b) 29,699 29,220 2.46%, due 7/1/2042 (a)(b) 39,112 39,771 55



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS - (Continued) DECEMBER 31, 2013 Face Amount Fair Value 2.52%, due 11/1/2042 (a)(b) 36,896 37,560 2.54%, due 7/1/2042 (a)(b) 33,904 34,563 2.55%, due 2/1/2043 (a)(b) 111,565 110,650 2.59%, due 3/1/2042 (a)(b) 29,871 30,638 2.79%, due 12/1/2041 (a)(b) 32,352 33,276 3.31%, due 1/1/2041 (a)(b) 27,151 28,537 3.50%, due 4/1/2026 - 2/1/2027 (a) 130,144



135,772

3.50%, due 5/1/2043 - 7/1/2043 (a) 428,429



425,633

4.00%, due 8/1/2043 - 2/1/2044 (a) 443,680



455,999

4.50%, due 12/1/2024 - 5/1/2025 (a) 35,497 37,736 Total Freddie Mac Pools 1,572,743 1,595,167 Ginnie Mae Pools - 13.9% (c) 3.00%, due 10/20/2028 (a) 154,038 158,293 3.50%, due 7/20/2040 (a)(b) 74,931 78,517 4.00%, due 1/20/2040 (a)(b) 8,650 9,105 Total Ginnie Mae Pools 237,619 245,915



Total Mortgage Pass-Through Agency RMBS (Cost - $13,923,271) 13,574,797

13,858,848

Other Investments - (Cost - $6,945) (d) 0.4% (c) 6,945



6,945

Total Investments in Securities (Cost - $13,930,216) $ 13,581,742

$ 13,865,793 Interest Rate Cap Contracts - 13.3%(c)(e) Expiration Cap Rate Notional Amount Fair Value 10/15/2015 1.43 % $ 300,000 $ 164 11/8/2015 1.36 % 200,000 145 5/23/2019 2.00 % 300,000 12,853 6/1/2019 1.75 % 300,000 14,679 6/29/2019 1.50 % 300,000 16,539 7/2/2019 1.50 % 300,000 16,970 7/16/2019 1.25 % 500,000 31,335 3/26/2020 1.25 % 500,000 41,322 3/30/2020 1.25 % 700,000 57,785 5/20/2020 1.25 % 500,000 42,911



Total Interest Rate Cap Contracts (Cost, $137,117) $ 3,900,000$ 234,703

56



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS - (Continued) DECEMBER 31, 2013 Interest Rate Swap Contracts - 1.8%(c)(e) Expiration Pay Rate Notional Amount Fair Value 2/14/2015 2.15 % $ 500,000 $ (10,255 ) 6/2/2016 1.94 % 300,000 (9,526 ) 12/19/2016 1.43 % 250,000 (4,255 ) 4/24/2017 1.31 % 500,000 (4,982 ) 7/13/2017 0.86 % 750,000 6,583 9/6/2017 0.77 % 250,000 3,755 9/6/2017 0.77 % 500,000 7,407 9/6/2017 0.77 % 250,000 3,804 11/7/2017 1.11 % 500,000 3,240 11/29/2017 0.87 % 500,000 8,136 2/21/2018 1.02 % 500,000 7,948 2/27/2018 0.96 % 500,000 9,226 4/25/2018(f) 1.01 % 500,000 10,905 8/15/2018 1.65 % 500,000 (440 ) Interest Rate Swap Contracts (Cost, $0) $ 6,300,000$ 31,546 __________________ LEGEND



(a) Securities or a portion of the securities are pledged as collateral for

repurchase agreements or interest rate swap contracts or forward settling

transactions.

(b) The coupon rate shown on floating or adjustable rate securities represents

the rate at December 31, 2013.

(c) Percentage of net assets.

(d) Comprised of investments that were individually less than 1% of net assets.

(e) The Company's interest rate swap contracts receive a floating rate set

quarterly to three month LIBOR. Interest rate caps receive a floating rate

quarterly in the amount of three month LIBOR that is in excess of the cap

rate. (f) The interest rate swap effective date is April 25, 2014, and it does not accrue any income or expense until that date. See notes to financial statements. 57



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS - (Continued) DECEMBER 31, 2012 INVESTMENTS IN SECURITIES - UNITED STATES OF AMERICA (In thousands) Face Amount Fair Value Fixed Income Securities - 868.3%(c) Mortgage Pass-Through Agency RMBS - 865.9%(c) Fannie Mae Pools - 822.8%(c) 2.15%, due 2/1/2043(b) $ 100,000$ 103,991 2.16%, due 10/1/2042(b) 44,800 46,452 2.17%, due 3/1/2043(b) 30,000 31,167 2.18%, due 11/1/2042(b) 34,926 36,246 2.24%, due 10/1/2042(b) 49,605 51,511 2.26%, due 11/1/2042(b) 45,372 47,149 2.34%, due 11/1/2042(b) 75,085 78,162 2.38%, due 1/1/2043(a)(b) 100,237 104,444 2.40%, due 9/1/2042 - 10/1/2042(a)(b) 63,216 65,915 2.41%, due 7/1/2042 - 9/1/2042(a)(b) 69,629 72,585 2.42%, due 11/1/2042(a)(b) 75,395 78,710 2.43%, due 2/1/2043(b) 25,000 26,174 2.44%, due 7/1/2042 - 10/1/2042(a)(b) 241,204 251,833 2.45%, due 10/1/2042 - 11/1/2042(b) 87,021 90,808 2.46%, due 6/1/2042(a)(b) 57,508 60,021 2.50%, due 2/1/2028 - 3/1/2028 1,900,000 1,985,203 2.51%, due 10/1/2042(a)(b) 146,723 153,519 2.57%, due 7/1/2042 - 2/1/2043(a)(b) 130,372 136,513 2.58%, due 8/1/2042(a)(b) 34,217 35,801 2.60%, due 2/1/2043(b) 50,000 52,406 2.62%, due 7/1/2042(a)(b) 46,138 48,256 2.63%, due 4/1/2042(a)(b) 35,609 37,264 2.70%, due 6/1/2042(a)(b) 67,729 70,933 2.79%, due 1/1/2042 - 3/1/2042(a)(b) 85,732 89,912 2.80%, due 2/1/2042 - 11/1/2042(a)(b) 349,671 366,718 2.81%, due 2/1/2042(a)(b) 55,367 58,090 2.84%, due 2/1/2042(a)(b) 32,607 34,247 2.85%, due 12/1/2041(a)(b) 53,238 55,952 2.87%, due 1/1/2042(a)(b) 59,639 63,234 2.89%, due 2/1/2042(a)(b) 40,377 42,409 3.00%, due 1/1/2041(a)(b) 29,557 31,002 3.00%, due 2/1/2027 - 12/1/2027(a) 6,794,861 7,183,772 3.00%, due 2/1/2032 - 2/1/2033(a) 967,503 1,018,411 3.00%, due 10/1/2042(a) 46,277 47,556 3.02%, due 12/1/2040(a)(b) 101,591 106,680 3.04%, due 9/1/2041(a)(b) 38,752 40,639 3.05%, due 9/1/2041(a)(b) 36,363 38,205 3.06%, due 6/1/2042(b) 37,791 40,031 3.16%, due 9/1/2041(a)(b) 31,611 33,343 3.18%, due 11/1/2041(a)(b) 27,672 29,179 3.21%, due 9/1/2041(a)(b) 84,111 88,670 58



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS - (Continued) DECEMBER 31, 2012 Face Amount Fair Value 3.24%, due 3/1/2041(a)(b) $ 15,547$ 16,389 3.26%, due 4/1/2041(a)(b) 38,941 40,970 3.30%, due 5/1/2041(a)(b) 31,843 33,499 3.35%, due 8/1/2041(a)(b) 27,024 28,827 3.36%, due 6/1/2041(a)(b) 81,763 86,263 3.38%, due 5/1/2041(a)(b) 17,894 18,822 3.50%, due 7/1/2021(a) 207,091 219,747 3.50%, due 12/1/2025 - 2/1/2028(a) 1,481,478



1,572,774

3.50%, due 8/1/2042 - 3/1/2043(a) 3,209,041 3,425,338 3.61%, due 6/1/2041(a)(b) 49,197 52,170 3.65%, due 7/1/2040(a)(b) 29,174 30,810 3.99%, due 9/1/2039(b) 11,717 12,432 4.00%, due 1/1/2025 - 6/1/2026(a) 613,772



657,599

4.00%, due 8/1/2042(a) 106,594



114,664

4.50%, due 2/1/2028 - 11/1/2030(a) 136,333 147,730 4.50%, due 11/1/2041(a) 256,057 277,486 Total Fannie Mae Pools 18,695,972 19,768,633 Freddie Mac Pools - 38.0%(c) 2.22%, due 12/1/2042(b) 50,184 52,100 2.30%, due 11/1/2042(a)(b) 99,093 103,022 2.43%, due 6/1/2042(a)(b) 38,618 40,336 2.45%, due 7/1/2042(a)(b) 46,980 49,027 2.52%, due 9/1/2042(a)(b) 122,825 128,547 2.54%, due 7/1/2042(a)(b) 41,200 43,077 2.55%, due 11/1/2042(b) 54,278 56,826 2.59%, due 3/1/2042(a)(b) 35,421 37,203 2.79%, due 12/1/2041(a)(b) 42,260 44,357 3.27%, due 6/1/2041(a)(b) 32,330 33,995 3.30%, due 1/1/2041(a)(b) 35,460 37,608 3.50%, due 4/1/2026 - 2/1/2027(a) 187,349



197,014

3.63%, due 6/1/2041(a)(b) 32,394



34,105

4.50%, due 12/1/2024 - 5/1/2025(a) 52,637 56,006 Total Freddie Mac Pools 871,029 913,223 Ginnie Mae Pools - 5.1%(c) 3.50%, due 7/20/2040(a)(b) 101,626 108,469 4.00%, due 1/20/2040(a)(b) 12,875 13,818 Total Ginnie Mae Pools 114,501 122,287



Total Mortgage Pass-Through Agency RMBS (Cost - $20,560,760) 19,681,502

20,804,143

U.S. Treasury Bills - 1.6%(c) 0.06%, due 2/7/2013(a)(d) 38,000



37,999

Total U.S. Treasury Bills (Cost - $37,995) 38,000



37,999

Other investments (Cost - $12,855)(e) - 0.8%(c) 20,473



19,576

Total Investments in Securities (Cost - $20,611,610) $ 19,739,975

$ 20,861,718 59



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS - (Continued) DECEMBER 31, 2012 Interest Rate Cap Contracts - 5.1%(c)(f) Expiration Cap Rate Notional Amount Fair Value 12/30/2014 2.07 % $ 200,000 $ 38 10/15/2015 1.43 % 300,000 386 11/8/2015 1.36 % 200,000 302 5/23/2019 2.00 % 300,000 6,714 6/1/2019 1.75 % 300,000 7,553 6/29/2019 1.50 % 300,000 8,686 7/2/2019 1.50 % 300,000 9,165 7/16/2019 1.25 % 500,000 17,255 7/16/2022 1.75 % 500,000 36,010 7/25/2022 1.75 % 500,000 36,880



Total Interest Rate Cap Contracts (Cost, $134,815) $ 3,400,000$ 122,989

Interest Rate Swap Contracts - (4.1%)(c)(f) Expiration Pay Rate Notional Amount Fair Value 5/26/2013 1.60 % $ 100,000 $ (529 ) 6/28/2013 1.38 % 300,000 (1,574 ) 7/15/2013 1.37 % 300,000 (1,706 ) 12/15/2013 1.31 % 400,000 (3,773 ) 12/16/2013 1.26 % 400,000 (3,602 ) 12/16/2013 1.28 % 500,000 (4,581 ) 12/17/2013 1.32 % 400,000 (3,838 ) 7/1/2014 1.72 % 100,000 (2,049 ) 7/16/2014 1.73 % 250,000 (5,309 ) 8/16/2014 1.35 % 200,000 (3,246 ) 9/23/2014 1.31 % 500,000 (8,167 ) 10/6/2014 1.17 % 240,000 (3,405 ) 2/14/2015 2.15 % 500,000 (18,564 ) 6/2/2016 1.94 % 300,000 (14,320 ) 12/19/2016 1.43 % 250,000 (7,996 ) 4/24/2017(g) 1.31 % 500,000 (11,556 ) 7/13/2017 0.86 % 750,000 (4,117 ) 9/6/2017 0.77 % 250,000 33 9/6/2017 0.77 % 250,000 26 9/6/2017 0.77 % 500,000 (243 ) 11/29/2017(h) 0.87 % 500,000 1,121 Interest Rate Swap Contracts (Cost, $0) $ 7,490,000$ (97,395 ) __________________ LEGEND



(a) Securities or a portion of the securities are pledged as collateral for

repurchase agreements, interest rate swap contracts or forward settling

transactions.

(b) The coupon rate shown on floating or adjustable rate securities represents

the rate at December 31, 2012.

(c) Percentage of net assets.

(d) Zero coupon bond, rate shown represents purchase yield.

(e) Comprised of investments that were individually less than 1% of net assets.

60



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Table of Contents CYS INVESTMENTS, INC. SCHEDULES OF INVESTMENTS - (Continued) DECEMBER 31, 2012 (f) The Company's interest rate swap contracts receive a floating rate set



quarterly to three month LIBOR. Interest rate caps receive a floating rate

quarterly in the amount of three month LIBOR that is in excess of the cap

rate. (g) The interest rate swap effective date is April 24, 2013 and does not accrue any income or expense until that date. (h) The interest rate swap effective date is November 29, 2013 and does not accrue any income or expense until that date. See notes to financial statements. 61



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Table of Contents CYS INVESTMENTS, INC. STATEMENTS OF OPERATIONS Year Ended December 31, (In thousands, except per share numbers) 2013 2012



2011

INVESTMENT INCOME: Interest income from Agency RMBS $ 330,430$ 288,960$ 228,768 Other income 1,601 4,366 4,129 Total investment income 332,031 293,326 232,897 EXPENSES: Interest 52,763 44,117 18,789 Management fees - - 8,442 Compensation and benefits 12,599 12,264 7,837 General, administrative and other 8,436 8,261 6,910 Total expenses 73,798 64,642 41,978 Net investment income 258,233 228,684 190,919 GAINS AND (LOSSES) FROM INVESTMENTS: Net realized gain (loss) on investments (595,116 ) 203,846



35,756

Net unrealized appreciation (depreciation) on investments (314,530 ) 23,023



225,660

Net gain (loss) from investments (909,646 ) 226,869



261,416

GAINS AND (LOSSES) FROM SWAP AND CAP CONTRACTS: Net swap and cap interest income (expense) (93,497 ) (60,776 ) (55,487 ) Net gain (loss) on termination of swap and cap contracts 30,775 - (4,903 ) Net unrealized appreciation (depreciation) on swap and cap contracts 238,353 (21,990 ) (100,012 ) Net gain (loss) from swap and cap contracts 175,631 (82,766 ) (160,402 ) NET INCOME (LOSS) $ (475,782 )$ 372,787$ 291,933 DIVIDENDS ON PREFERRED SHARES (15,854 ) (2,405 ) -



NET INCOME (LOSS) AVAILABLE TO COMMON SHARES $ (491,636 )$ 370,382

$ 291,933 NET INCOME (LOSS) PER COMMON SHARE BASIC & DILUTED $ (2.90 )$ 2.64$ 3.66 See notes to financial statements. 62



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Table of Contents CYS INVESTMENTS, INC. STATEMENTS OF CHANGES IN NET ASSETS Year Ended December 31, (In thousands) 2013 2012 2011 Net income (loss): Net investment income $ 258,233$ 228,684$ 190,919 Net realized gain (loss) on investments (595,116 ) 203,846



35,756

Net unrealized appreciation (depreciation) on investments (314,530 ) 23,023



225,660

Net gain (loss) from swap and cap contracts 175,631 (82,766 ) (160,402 ) Net income (loss)

(475,782 ) 372,787



291,933

Dividends on preferred shares (15,854 ) (2,405 ) -



Net income (loss) available to common shares (491,636 ) 370,382

291,933

Capital transactions: Net proceeds from issuance of common stock (552 ) 1,236,807



275,898

Net payments from repurchase of common stock (115,735 ) - -



Net proceeds from issuance of preferred stock 193,531 72,369

- Distributions on common shares (146,466 ) (357,188 ) (162,455 ) Tax return of capital distributions (76,619 ) - (23,520 ) Amortization of share based compensation 3,471 2,834



5,263

Increase (decrease) in net assets from capital transactions (142,370 ) 954,822



95,186

Total (decrease) increase in net assets (634,006 ) 1,325,204 387,119 Net assets: Beginning of period 2,402,662 1,077,458 690,339 End of period $ 1,768,656$ 2,402,662$ 1,077,458 See notes to financial statements. 63



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Table of Contents CYS INVESTMENTS, INC. STATEMENTS OF CASH FLOWS Year Ended December 31, (In thousands) 2013 2012 2011 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (475,782 )$ 372,787$ 291,933 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Purchase of investment securities (44,752,803 ) (33,654,947 ) (7,093,540 ) Premium paid on interest rate caps (91,860 ) (133,483 ) - Proceeds from disposition of investment securities 48,296,551 19,484,757 2,769,867 Proceeds from paydowns of investment securities 2,427,118 2,889,821 1,406,114 Proceeds from termination of interest rate cap contracts 103,275 - - Amortization of share based compensation 3,471 2,834 5,263 Amortization of premiums and discounts on investment securities 115,413 111,647 43,895 Amortization of premiums on interest rate cap contracts 24,240 12,390 3,838 Net realized (gain) loss on investments 595,116 (203,846 ) (35,756 ) Net (gain) loss on termination of cap contracts (37,957 ) - - Net unrealized (appreciation) depreciation on investments 314,530 (23,023 ) (225,660 ) Net unrealized (appreciation) depreciation on swap and cap contracts (238,353 ) 21,990 100,012 Change in assets and liabilities: Receivable for securities sold and principal repayments (418,890 ) (4,793 ) (5,550 ) Interest receivable 9,827 (18,743 ) (11,632 ) Other assets 218 264 (661 ) Payable for securities purchased (2,958,680 ) 4,052,199 (1,771,099 ) Accrued interest payable (4,250 ) 13,246 6,205 Related party management fee payable - - (800 ) Accrued expenses and other liabilities 3,783 (955 ) 675 Payable for cash received as collateral 9,028 28,910 - Net cash provided by (used in) operating activities 2,923,995 (7,048,945 ) (4,516,896 ) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from repurchase agreements 115,545,756 79,752,751 43,998,829 Repayments of repurchase agreements (118,320,113 ) (73,652,258 ) (39,561,858 ) Net proceeds from issuance of common stock (552 ) 1,236,807 275,884 Net payments from repurchase of common stock (115,735 ) - - Net proceeds from issuance of preferred stock 193,531 72,369 - Distributions paid (235,772 ) (358,350 ) (185,961 ) Net cash provided by (used in) financing activities (2,932,885 ) 7,051,319 4,526,894 Net increase (decrease) in cash and cash equivalents (8,890 ) 2,374 9,998 CASH AND CASH EQUIVALENTS - Beginning of period 13,882 11,508 1,510 CASH AND CASH EQUIVALENTS - End of period $ 4,992$ 13,882$ 11,508 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 135,920 $



92,322 $ 70,691 SUPPLEMENTAL DISCLOSURES OF NONCASH FLOW INFORMATION: Distributions declared, not yet paid

$ 4,410$ 1,243 $ - Reinvestment of distributions on common shares $ - $ 1,294 $ 14 See notes to financial statements. 64



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Table of Contents CYS INVESTMENTS, INC. NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION CYS Investments, Inc. (the "Company") was formed as a Maryland corporation on January 3, 2006, and commenced operations on February 10, 2006. The Company has elected to be taxed and intends to continue to qualify as a real estate investment trust ("REIT") and is required to comply with the provisions of the Internal Revenue Code of 1986, as amended (the "Code"), with respect thereto. Since March 2008, the Company has primarily purchased residential mortgage-backed securities that are issued and the principal and interest of which are guaranteed by a federally chartered corporation ("Agency RMBS"), 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"), or debt securities issued by the United States Department of Treasury ("U.S. Treasury Securities"). On December 10, 2012 the Company's board of directors amended and restated its investment guidelines to permit the company to invest in (i) Agency RMBS, (ii) collateralized mortgage obligations issued by a government agency or government-sponsored entity that are collateralized by Agency RMBS and (iii) U.S. Treasury Securities or, a government sponsored entity that is not backed by collateral but, in the case of government agencies, is backed by the full faith and credit of the U.S. government, and, in the case of government sponsored entities, is backed by the integrity and creditworthiness of the issuer ("U.S. Agency Debentures"). The Company's common stock, Series A Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A Preferred Stock"), and Series B Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series B Preferred Stock"), trade on the New York Stock Exchange under the symbols "CYS," "CYS PrA" and "CYS PrB," respectively. On September 1, 2011, the Company acquired certain assets and entered into agreements to internalize the Company's management (the "Internalization"). Prior to the Internalization, the Company had been managed by Cypress Sharpridge Advisors LLC (the "Manager") pursuant to a management agreement (the "Management Agreement"). The Manager had entered into sub-advisory agreements with Sharpridge Capital Management, L.P. ("Sharpridge") and an affiliate of The Cypress Group, pursuant to which the Manager was provided with all of the resources and assets (the "Assets") used to operate the Company's business and manage the Company's assets. In connection with the completion of the Internalization, the Management Agreement, sub-advisory agreements and other ancillary agreements related thereto were terminated. No termination fee was incurred or paid as a result of terminating those agreements. In connection with the Internalization, the Company changed its name from "Cypress Sharpridge Investments, Inc." to "CYS Investments, Inc." on September 1, 2011. The results of the Internalization were not material to the Company's results of operations. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). The Company adopted Financial Accounting Standards Board ("FASB") 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. Under ASC 946, the Company uses financial reporting for investment companies. Segment Reporting The Company operates as a single segment reporting to the Chief Executive Officer, who manages the entire investment portfolio. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates include, but are not limited to, investment valuation. Actual results could differ from those management estimates. Cash and Cash Equivalents Cash and cash equivalents include cash on hand, cash held in banks and highly liquid investments with original maturities of three months or less. Interest income earned on cash and cash equivalents is recorded in other income. Offsetting Repurchase agreements and derivative contracts are entered into by the Company under Master Repurchase Agreements ("MRA") and International Standard Derivative Agreements ("ISDA"). Pursuant to the terms of the MRA or ISDA, the Company receives or posts securities and/or cash as collateral with a market value that may be in excess of the purchase price to be paid or received by the Company upon the maturity of the transaction. With repurchase agreements and 65



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derivatives, typically the Company and the counterparties are permitted to sell, re-pledge, or use the collateral associated with the transaction. MRAs and ISDAs may include provisions that permit the Company and/or a counterparty, under certain circumstances, including under defined events of default, to offset payables and/or receivables under transactions entered into pursuant to the terms of an MRA or ISDA with collateral held and/or posted to the counterparty and create one single net payment due to or from the Company. However, bankruptcy or insolvency laws of a particular jurisdiction under which a counterparty may become subject in the event of an MRA or ISDA counterparty's bankruptcy or insolvency may impose restrictions on or prohibitions against any such right of offset. Upon a bankruptcy or insolvency of an MRA or ISDA counterparty, the Company may be considered an unsecured creditor with respect to excess collateral pledged to the counterparty and, as such, the return of excess collateral may be delayed, the amount returned reduced, or otherwise prohibited, depending on the final determination and outcome of any such bankruptcy or insolvency proceedings. The Company reports amounts subject to its' MRAs and ISDAs in the statement of assets and liabilities on a gross basis without regard for such rights of offset. At December 31, 2013, the Company's derivative assets and liabilities (by type) are as follows (in millions): Assets Liabilities Interest rate swap contracts $ 61.0$ 29.5 Interest rate cap contracts 234.7 -



Total derivative assets and liabilities in the Statements of Assets and Liabilities

295.7 29.5



Derivatives not subject to a master netting agreement or similar agreement ("MNA")

11.2 0.4 Total assets and liabilities subject to a MNA $ 284.5



$ 29.1

Below is a summary of the Company's assets subject to offsetting provisions (in millions):

Gross Amounts Not Offset in the

Statement of Assets and Liabilities

Net Amounts of Assets Presented in the Instruments Statement of Assets and Available for Collateral As of Description Liabilities Offset Received(1) Net Amount(2) December 31, 2013 Derivative assets $ 284.5 $ 9.2 $ 244.7 $ 30.6 December 31, 2012 Derivative assets 124.2 34.1 47.3 42.8 (1) Collateral consists of Agency RMBS, U.S. Treasuries and cash. Excess of collateral received is not shown for financial reporting purposes. (2) Net amount represents the net amount receivable from the counterparty in the event of default. Below is a summary of the Company's liabilities subject to offsetting provisions (in millions): Gross Amounts Not Offset in the Statement of Assets and Liabilities Net Amounts of Liabilities Instruments Presented in the Statement Available for Collateral As of Description of Assets and Liabilities Offset Pledged(1) Net Amount(2) Derivative December 31, 2013 liabilities $ 29.1 $ 9.2 $ 19.8 $ - Repurchase December 31, 2013 agreements 11,207.0 - 11,207.0 - Derivative December 31, 2012 liabilities 98.6 34.1 64.5 - Repurchase December 31, 2012 agreements 13,981.3 - 13,981.3 - (1) Collateral consists of Agency RMBS, U.S. Treasuries and cash. Further detail of collateral pledged on repurchase agreements is disclosed in note 5. Excess of collateral pledged is not shown for financial reporting purposes. (2) Net amount represents the net amount payable from the counterparty in the event of default. Interest Rate Swap and Cap Contracts The Company utilizes interest rate swaps and caps to hedge the interest rate risk associated with the financing of its portfolio. Specifically, the Company seeks to hedge the exposure to potential interest rate mismatches between the interest earned on investments and the borrowing costs caused by fluctuations in short term interest rates. In a simple interest rate swap, 66



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one investor pays a floating rate of interest on a notional principal amount and receives a fixed rate of interest on the same notional principal amount for a specified period of time. Alternatively, an investor may pay a fixed rate and receive a floating rate. 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"). If the floating interest rate (the "floating rate") 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 the cap rate and floating rate. During the term of the interest rate swap or cap, the Company makes or receives periodic payments and unrealized gains or losses are recorded as a result of marking the swap and cap to their fair value. When the swap or cap is terminated, the Company records a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company's cost basis in the contract, if any. The periodic payments, amortization of premiums on cap contracts and any realized or unrealized gains or losses are reported under gains and losses from swap and cap contracts in the statements of operations. Swaps involve a risk that interest rates will move contrary to the Company's expectations, thereby increasing the Company's payment obligation. Because the Company uses financial reporting for investment companies, its investments, including its interest rate swap and cap contracts, are carried at fair value with changes in fair value included in earnings. Consequently, there would be no impact to designating interest rate swaps and caps as cash flow or fair value hedges under GAAP. The interest rate swap and cap contracts and collateral posted or received on the contracts are valued daily and counterparties may require additional collateral when the fair value of the contracts or collateral declines. Conversely, the Company may require the counterparty to post collateral to it when the fair value of the contracts or collateral increases. The Company's interest rate swap and cap contracts are subject to master netting arrangements. The Company is exposed to credit loss in the event of nonperformance by the counterparty to the swap or cap limited to the fair value of collateral posted in excess of the fair value of the contract in a net liability position and the shortage of the fair value of collateral posted for the contract in a net asset position. As of December 31, 2013 and 2012, the Company did not anticipate nonperformance by any counterparty. Should interest rates move unexpectedly, the Company may not achieve the anticipated benefits of the interest rate swap or cap and may realize a loss. Investment Valuation The Company has established a pricing committee responsible for establishing valuation policies and procedures as well as approving valuations on a monthly basis at a pricing meeting. The pricing committee is made up of individuals from the accounting team, the investment team and senior management. Agency RMBS, U.S. Agency Debentures and U.S. Treasury Securities are generally valued on the basis of valuations provided by third party pricing services, as derived from such services' pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. Interest rate swaps and caps are generally valued with level two inputs using valuations provided by broker quotations. Such broker quotations are based on the present value of fixed and projected floating rate cash flows over the term of the swap contract. Future cash flows are discounted to their present value using swap rates provided by electronic data services or brokers. No credit valuation adjustments were made in determining the fair value of the Company's interest rate swaps and caps. Fair values of long-lived assets, including real estate, are primarily derived internally and are based on inputs observed from sales transactions for similar assets. For real estate, fair values are based on discounted cash flow estimates which reflect current and projected lease profiles and available industry information about capitalization rates and expected trends in rents and occupancy. All valuations received from third party pricing services or broker quotes are non-binding. To date, the Company has not adjusted any of the prices received from third party pricing services or brokers, and all prices are reviewed by the Company. This review includes comparisons of similar market transactions, alternative third party pricing services and broker quotes, or comparisons to a pricing model. To ensure the proper classification within the fair value hierarchy, the Company reviews the third party pricing service's methodology to understand whether observable or unobservable inputs are being used. Agency RMBS The Company's investments in Agency RMBS consist of pass-through certificates backed by fixed rate, monthly reset adjustable-rate loans ("ARMs") and hybrid ARMs, the principal and interest of which are guaranteed by Fannie Mae, Freddie 67



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Mac or Ginnie Mae. Hybrid ARMs have interest rates that have an initial fixed period (typically three, five, seven or ten years) and thereafter reset at regular intervals in a manner similar to ARMs. Forward Settling Transactions The Company engages in forward settling transactions to purchase certain securities. The Company records forward settling transactions on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment on the settlement date for the securities purchased. Securities purchased on a forward settling basis are carried at fair value and only begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market conditions or the failure of counterparties to perform under the contract. Among other forward settling transactions, the Company from time to time transacts in to-be-announced securities ("TBAs"). As with other forward settling transactions, a seller agrees to issue TBAs at a future date. However, the seller does not specify the particular securities to be delivered. Instead, the Company agrees to accept any security that meets specified terms such as issuer, interest rate and terms of underlying mortgages. The Company records TBAs on the trade date utilizing information associated with the specified terms of the transaction as opposed to the specific mortgages. TBAs are carried at fair value and begin earning interest on the settlement date. Losses may occur due to the fact that the actual underlying mortgages received may be less favorable than those anticipated by the Company. As of December 31, 2013 and 2012 the Company had pledged Agency RMBS with a fair value of $12.3 million and $10.4 million, respectively, on its open forward settling transactions. Repurchase Agreements Repurchase agreements are secured borrowings that are collateralized by the Company's Agency RMBS and are carried at their amortized cost, which approximates their fair value due to their short term nature, generally 30-90 days. The Company's repurchase agreements are with a diversified group of commercial and investment banks. Collateral is valued daily and counterparties may require additional collateral when the fair value of the collateral declines. Conversely, the Company may require the counterparty to post collateral to it when the fair value of the collateral increases. Counterparties have the right to sell or repledge collateral pledged for repurchase agreements, however they are required to return collateral that is the same or substantially similar to the original collateral. Investment Transactions and Income The Company records its transactions in securities on a trade date basis. Realized gains and losses on securities transactions are recorded on an identified cost basis. Interest income and expense are recorded on the accrual basis. Interest income on Agency RMBS is accrued based on outstanding principal amount of the securities and their contractual terms. Interest on CLOs was accrued at a rate determined based on estimated future cash flows and adjusted prospectively as future cash flow amounts were recast. For CLOs placed on nonaccrual status or when the Company could not reliably estimate cash flows, the cost recovery method was used. Amortization of premium and accretion of discount are recorded using the yield to maturity method, and are included in investment income in the statements of operations. The Company does not estimate prepayments when calculating the yield to maturity. The amount of premium or discount associated with a prepayment is recorded through investment income on the statements of operations as they occur. Compensation and Benefits Included in the Company's compensation and benefits are salaries, incentive compensation, benefits, share based compensation and the expense relating to restricted common stock granted to non-employees (prior to the Internalization). The Company accounts for share based compensation using the fair value based methodology prescribed by ASC 718, Share Based Payment ("ASC 718"). Compensation cost related to restricted common stock issued is measured at its estimated fair value at the grant date and recognized as expense over the vesting period. Prior to the Internalization, compensation cost related to restricted common stock and common stock options issued to the Company's executive officers, certain employees of its Manager and its sub-advisors and other individuals who provided services to the Company, was initially measured at estimated fair value at the grant date and was remeasured on subsequent dates to the extent the awards were unvested. Income Taxes The Company has elected to be taxed as a REIT and intends to continue to comply with provisions of the Code with respect thereto. As a REIT, the Company generally will not be subject to federal or state income tax on income that it currently distributes to its stockholders. To maintain its qualification as a REIT, the Company must distribute at least 90% of its REIT taxable income to its stockholders and meet certain other tests relating to assets and income. Earnings Per Share ("EPS") Basic EPS is computed using the two class method by dividing net income (loss), after adjusting for the impact of unvested stock awards deemed to be participating securities, by the weighted average number of common shares outstanding 68



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calculated excluding unvested stock awards. Diluted EPS is computed by dividing net income (loss), after adjusting for the impact of unvested stock awards deemed to be participating securities, by the weighted average number of common shares outstanding calculated excluding unvested stock awards, giving effect to common stock options and warrants, if they are not anti-dilutive. See Note 3 for EPS computations. Recent Accounting Pronouncements In June 2013, the FASB issued ASU 2013-08, Financial Services-Investment Companies (Topic 946). This update modifies the guidance for Topic 946 for determining whether an entity is an investment company for GAAP purposes. Because the Company adopted Statement of Position 07-1 prior to its indefinite deferral, this update required management to assess whether the Company continues to meet the definition of an investment company for GAAP purposes. The guidance is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013, with prospective application. Earlier application is prohibited. Management has performed its assessment and determined that the Company does not meet the definition of an investment company in accordance with Topic 946. As a result, the Company will discontinue application of Topic 946 and shall account for its investments in conformity with applicable non-investment company U.S. GAAP, with prospective application on the effective date. Management does not expect there will be any cumulative effect adjustments to retained earnings upon adoption as all investments will continue to be recorded at fair value on the balance sheet subsequent to adoption. See Note 14, "Subsequent Events", for additional information.



3. EARNINGS PER SHARE Components of the computation of basic and diluted EPS under the two-class method were as follows (in thousands, except per share numbers):

Year Ended December 31, 2013 2012 2011 Net income (loss) $ (475,782 )$ 372,787$ 291,933 Less dividend on preferred shares (15,854 ) (2,405 )



-

Net income (loss) available to common shares (491,636 ) 370,382 291,933 Less dividends paid: Common shares (221,957 ) (355,548 ) (184,383 ) Unvested shares (1,128 ) (1,640 ) (1,592 ) Undistributed earnings (loss) $ (714,721 )$ 13,194 $



105,958

Basic weighted average shares outstanding: Common shares 169,967 139,651



78,992

Basic earnings (loss) per common share: Distributed earnings $ 1.31$ 2.55 $



2.33

Undistributed earnings (4.21 ) 0.09



1.33

Basic earnings (loss) per common share $ (2.90 )$ 2.64 $

3.66

Diluted weighted average shares outstanding: Common shares 169,967 139,651



78,992

Net effect of dilutive warrants (1) - -



1

169,967 139,651



78,993

Diluted earnings (loss) per common share: Distributed earnings $ 1.31$ 2.55 $



2.33

Undistributed earnings (4.21 ) 0.09



1.33

Diluted earnings (loss) per common share $ (2.90 )$ 2.64 $

3.66 __________________



(1) For the year ended December 31, 2013, 2012 and 2011, the Company had an

aggregate of 131 stock options outstanding with a weighted average

exercise price of $30.00 that were not included in the calculation of EPS,

as their inclusion would have been anti-dilutive. These instruments may have a dilutive impact on future EPS.



4. INVESTMENTS IN SECURITIES AND INTEREST RATE SWAP AND CAP CONTRACTS AND OTHER ASSETS

69



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The Company's valuation techniques use observable and unobservable inputs. Observable inputs reflect the assumptions market participants would use in pricing an asset or liability developed based on market data obtained from sources independent of the Company, while unobservable inputs reflect the Company's own assumptions about the assumptions market participants would use in pricing an asset or liability developed based on the best information available in the circumstances. ASC 820, Fair Value Measurements, classifies these inputs into the following hierarchy: Level 1 Inputs-Quoted prices for identical instruments in active markets. Level 2 Inputs-Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Level 3 Inputs-Instruments with primarily unobservable value drivers. Excluded from the tables below are financial instruments carried on the accompanying financial statements at cost basis, which is deemed to approximate fair value, primarily due to the short duration of these instruments, including cash and cash equivalents, receivables, payables and borrowings under repurchase arrangements with initial terms of one year or less. As of December 31, 2013 and 2012, the fair value of these instruments is determined using level two inputs. There were no transfers between Level 1, Level 2 or Level 3 during 2013 and 2012. The following tables provide a summary of the Company's assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2013 and 2012 (in thousands): December 31, 2013 Fair Value Measurements Using Assets Level 1 Level 2 Level 3 Total Agency RMBS $ - $ 13,858,848 $ - $ 13,858,848 Other investments - - 6,945 6,945 Derivative assets - 295,707 - 295,707 Total $ - $ 14,154,555$ 6,945$ 14,161,500 Liabilities Derivative liabilities $ - $ 29,458 $ - $ 29,458 December 31, 2012 Fair Value Measurements Using Assets Level 1 Level 2 Level 3 Total Agency RMBS $ - $ 20,804,143 $ - $ 20,804,143 U.S. Treasury Bills 37,999 - - 37,999 Other investments - - 19,576 19,576 Derivative assets - 124,169 - 124,169 Total $ 37,999$ 20,928,312$ 19,576$ 20,985,887 Liabilities



Derivative liabilities $ - $ 98,575 $ - $ 98,575

Other investments is comprised of CLOs and real estate assets. The table below presents a reconciliation of changes in other investments classified as Level 3 in the Company's financial statements for the year ended December 31, 2013 and 2012. A discussion of the method of fair valuing these assets is included above in "Investment Valuation." CLOs are generally valued using valuations provided by broker quotations. The Company validates the broker quotations using internal discounted cash flow models. The significant unobservable inputs used in the fair value measurement of the Company's CLOs are prepayment rates, probability of default, and recovery rate in the event of default. Significant changes in any of those inputs in isolation would result in a materially different fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity upon default and a directionally opposite change in the assumption used for prepayment rates. The Company did not hold any CLOs as of December 31, 2013. The weighted average inputs to the models were: Constant Prepayment Rate Default Rate Recovery Rate Recovery Lag December 31, 2012 20 % 2 % 69 % 6 Months



Fair values of real estate assets are valued based on discounted cash flow models. A discussion of the method of fair valuing these assets is included above in Note 2 "Investment Valuation." The significant unobservable input used in the fair

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value measurement is capitalization rates, which the Company estimated to be between 3% and 5% at December 31, 2013 and 2012.

Level 3 Fair Value Reconciliation Year Ended December 31, (In thousands) 2013 2012 Other investments Beginning balance level 3 assets $ 19,576 $



18,675

Cash payments recorded as a reduction of cost basis (324 ) (3,464 ) Change in net unrealized appreciation (depreciation) (6,721 ) 3,364 Net purchases (sales) (12,005 ) (1,698 ) Net gain (loss) on sales 6,419 2,699 Transfers into (out of) level 3 -



-

Ending balance level 3 assets $ 6,945 $



19,576

The Agency RMBS portfolio consisted of Agency RMBS as follows: December 31, 2013 Face Value Fair Value

Weighted Average Asset Type (in thousands) Cost/Face Fair Value/Face MTR(1) Coupon CPR(2) 15 Year Fixed Rate $ 6,337,536$ 6,510,958$ 102.58 $ 102.74 N/A 3.13 % 5.3 % 20 Year Fixed Rate 84,730 90,795 103.07 107.16 N/A 4.50 % 16.0 % 30 Year Fixed Rate 5,145,151 5,214,548 102.15 101.35 N/A 3.78 % 3.6 % Hybrid ARMs 2,007,380 2,042,547 103.57



101.75 66.1 2.56 % 12.6 % Total/Weighted Average $ 13,574,797$ 13,858,848$ 102.57 $ 102.09

3.30 % 6.0 % December 31, 2012 Face Value Fair Value Weighted Average Asset Type (in thousands) Cost/Face Fair Value/Face MTR(1) Coupon CPR(2) 10 Year Fixed Rate $ 207,091$ 219,747$ 103.60 $ 106.11 N/A 3.50 % 19.4 % 15 Year Fixed Rate 11,092,374 11,717,136 104.32 105.63 N/A 3.05 % 16.1 % 20 Year Fixed Rate 1,087,835 1,148,932 104.96 105.62 N/A 3.17 % 10.1 % 30 Year Fixed Rate 3,571,692 3,817,488 105.78 106.88 N/A 3.59 % 8.9 % Hybrid ARMs 3,722,510 3,900,840 103.54 104.79 74.3 2.71 % 19.1 % Total/Weighted Average $ 19,681,502$ 20,804,143$ 104.47 $ 105.70 3.10 % 15.8 % __________________

(1) MTR, or "Months to Reset" is the weighted average 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 CPR is an annualized version of the prior three month prepayment rate.

Securities with no prepayment history are excluded from this calculation.

As of December 31, 2013 and 2012, the Company's Agency RMBS were purchased at a net premium to their face value with approximately $351.5 million and $879.6 million, respectively, of unamortized premium included in their cost basis. The premium purchase price is due to the average coupon interest rates on these investments being higher than prevailing market rates. The Company does not estimate prepayments when calculating the yield to maturity. During the years ended December 31, 2013, 2012 and 2011 the Company recorded $115.4 million, $111.6 million and $43.9 million, respectively, as net amortization of premium as a result prepayments. 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 December 31, 2013 and 2012, the average final contractual maturity of the Company's Agency RMBS portfolio is in year 2036 and 2033, respectively. 71



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In order to mitigate its interest rate exposure, the Company enters into interest rate swap and cap contracts. The Company had the following activity in interest rate swap and cap transactions during the years ended December 31, 2013 and 2012 (in thousands): Year Ended December 31, 2013 Year Ended December

31, 2012 Trade Date Transaction Notional Trade Date Transaction Notional February 2013 Opened $ 1,500,000 April 2012 Opened $ 500,000 March 2013 Terminated (500,000 ) May 2012 Opened 600,000 March 2013 Opened 1,200,000 June 2012 Opened 600,000 April 2013 Opened 500,000 July 2012 Opened 2,250,000 May 2013 Opened 500,000 September 2012 Opened 1,000,000 May 2013 Matured (100,000 ) November 2012 Opened 500,000 June 2013 Terminated (700,000 ) Net Increase $ 5,450,000 June 2013 Matured (300,000 ) July 2013 Matured (300,000 ) August 2013 Terminated (2,200,000 ) August 2013 Opened 500,000 November 2013 Terminated (940,000 ) November 2013 Opened 500,000 December 2013 Terminated (350,000 ) Net Decrease $ (690,000 ) As of December 31, 2013 and 2012, the Company had pledged Agency RMBS and U.S Treasury Securities with a fair value of $63.0 million and $127.6 million, respectively, as collateral on interest rate swap and cap contracts. In addition, the Company had Agency RMBS and U.S. Treasuries of $211.4 million and cash of $37.9 million pledged to it as collateral for its interest rate swap and cap contracts as of December 31, 2013. As of December 31, 2012, the Company had $18.4 million of Agency RMBS and U.S. Treasuries and $28.9 million of cash pledged to it as collateral for its interest rate swap and cap contracts. Below is a summary of our interest rate swap and cap contracts open as of December 31, 2013 and 2012 and the net gain (loss) on swap and cap contracts for the years ended December 31, 2013, 2012 and 2011 (in thousands): Derivatives not designated as hedging instruments under ASC 815(a) Interest Rate Swap Contracts Notional Amount Fair Value Statement of Assets and Liabilities Location December 31, 2013 $ 2,050,000$ (29,458 ) Derivative liabilities, at fair value December 31, 2013 4,250,000 61,004 Derivative assets, at fair value December 31, 2012 6,490,000 (98,575 ) Derivative liabilities, at fair value December 31, 2012 1,000,000 1,180



Derivative assets, at fair value

Interest Rate Cap Contracts Notional Amount Fair Value Statement of Assets and Liabilities Location December 31, 2013

$ 3,900,000$ 234,703 Derivative assets, at fair value December 31, 2012 3,400,000 122,989



Derivative assets, at fair value

Amount of Gain or (Loss) Recognized in Income on Derivatives Derivatives Not Designated as Hedging Location of Gain or (Loss) Year Ended December 31, Instruments Under ASC Recognized in Income on 815(a) Derivative 2013 2012 2011 Interest rate swap Net gain (loss) from swap and cap contracts and cap contracts $ 175,631



$ (82,766 )$ (160,402 )

__________________

(a) See Note 2 for additional information on the Company's purpose for entering into interest rate swaps and caps and the decision not to designate them as hedging instruments.



Credit Risk

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At December 31, 2013 and 2012, the Company continued to have minimal exposure to credit losses on its mortgage assets by owning principally Agency RMBS. The payment of principal and interest on Agency RMBS is guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae. In September 2008, both Freddie Mac and Fannie Mae were placed in the conservatorship of the United States government. On August 5, 2011, Standard & Poor's downgraded the U.S.'s credit rating to AA+ for the first time. Because Fannie Mae and Freddie Mac are in conservatorship of the U.S. Government, the implied credit ratings of Agency RMBS guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae were also downgraded to AA+. While this downgrade did not have a significant impact on the fair value of the Agency RMBS in the Company's portfolio, it has increased the uncertainty regarding the credit risk of Agency RMBS. 5. BORROWINGS The Company leverages its Agency RMBS portfolio through the use of repurchase agreements. Each of the borrowing vehicles used by the Company bears interest at floating rates based on a spread above or below LIBOR. The fair value of borrowings under repurchase agreements approximates their carrying amount due to the short term nature of these financial instruments. Certain information with respect to the Company's borrowings is summarized in the following tables. Each of the borrowings listed is contractually due in one year or less (dollars in thousands). December 31, 2013 Outstanding repurchase agreements $ 11,206,950 Interest accrued thereon $ 7,204 Weighted average borrowing rate 0.41 %



Weighted average remaining maturity (in days) 39.9 Fair value of the collateral(1)

$ 11,760,720 December 31, 2012 Outstanding repurchase agreements $ 13,981,307 Interest accrued thereon $ 11,717 Weighted average borrowing rate 0.48 %



Weighted average remaining maturity (in days) 19.6 Fair value of the collateral(1)

$ 14,693,645



__________________

(1) Collateral for repurchase agreements consisted of Agency RMBS and U.S. Treasury Securities. At December 31, 2013 and 2012, the Company did not have any borrowings under repurchase agreements where the amount at risk with an individual counterparty exceeded 10% of net assets. 6. SHARE CAPITAL The Company has authorized 500,000,000 shares of common stock having par value of $0.01 per share. As of December 31, 2013 and 2012, the Company had issued and outstanding 161,650,114 and 174,924,149 shares of common stock, respectively. The Company has authorized 50,000,000 shares of preferred stock having a par value of $0.01 per share. As of December 31, 2013 and 2012, 3,000,000 shares of 7.75% Series A Preferred Stock ($25.00 liquidation preference) were issued and outstanding. As of December 31, 2013, 8,000,000 shares of 7.50% Series B Preferred Stock ($25.00 liquidation preference) were issued and outstanding. The Series A Preferred Stock and Series B Preferred Stock will not be redeemable before August 3, 2017 and April 30 2018, respectively, except under circumstances where it is necessary to preserve the Company's qualification as a REIT, for federal income tax purposes or the occurrence of a change of control. On or after August 3, 2017 and April 30, 2018, respectively, the Company may, at its option, redeem any or all of the shares of the Series A Preferred Stock and Series B Preferred Stock, respectively, at $25.00 per share plus any accumulated and unpaid dividends to, but not including, the respective redemption date. The Series A Preferred Stock and Series B Preferred Stock have no stated maturity, and are not subject to any sinking fund or mandatory redemption. The Company's common and preferred stock transactions during the year ended December 31, 2013 and 2012 are as follows (in thousands): 73



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Table of Contents Year Ended December 31, 2013 Year Ended December 31, 2012 Common stock Shares Amount Shares Amount Common shares sold in public offerings or issued as restricted common stock 365 $ 3,279 92,113 $ 1,238,801 Shares issued in reinvestment of distributions - - 96 1,294 Shares repurchased or canceled (13,639 ) (116,095 ) (38 ) (453 ) Net increase (13,274 ) $ (112,816 ) 92,171 $ 1,239,642 Series A Preferred stock Preferred shares sold in public offerings - $ - 3,000 $ 72,369 Series B Preferred stock Preferred shares sold in public offerings 8,000 $ 193,531 - $ - Equity Offerings On February 1, 2012, the Company closed a public offering of 28,750,000 shares of its common stock at a public offering price of $13.28 per share for total net proceeds of approximately $377.3 million, after the underwriting discount and commissions and expenses. On July 16, 2012, the Company closed a public offering of 46,000,000 shares of its common stock at a public offering price of $13.70 per share for total net proceeds of approximately $622.2 million, after the underwriting discount and commissions and expenses. On August 3, 2012, the Company closed a public offering of 3,000,000 shares of its Series A Preferred Stock, liquidation preference of $25.00 per share, for total net proceeds of approximately $72.4 million, after the underwriting discount and commissions and expenses. On April 30, 2013, the Company closed a public offering of 8,000,000 shares of its Series B Preferred Stock, liquidation preference of $25.00 per share, for total net proceeds of approximately $193.6 million, after the underwriting discount and commissions and expenses. Dividend Reinvestment and Direct Stock Purchase Plan ("DSPP") The Company sponsors a dividend reinvestment and direct stock purchase plan through which 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 year ended December 31, 2013 the Company did not issue any shares under the DSPP. For the year ended December 31, 2012, the Company issued 5.3 million shares under the DSPP, raising approximately $74.0 million of net proceeds. As of December 31, 2013 and 2012, there were approximately 4.1 million shares, respectively, available for issuance under this plan. Restricted Common Stock Awards Refer to note 8-"Stock Options and Restricted Common Stock" for a summary of restricted common stock granted to certain of its directors, officers and employees for the years ended December 31, 2013, 2012 and 2011. Equity Placement Program ("EPP") On June 7, 2011, the Company entered into a sales agreement with JMP Securities LLC whereby the Company may, from time to time, publicly offer and sell up to 15.0 million shares of the Company's common stock through at-the-market transactions and/or privately negotiated transactions. For the year ended December 31, 2013, the Company did not issue any shares under the plan. For the year ended December 31, 2012, the Company issued 11.9 million shares under the EPP, raising approximately $164.3 million of net proceeds. As of December 31, 2013 and 2012, approximately 3.1 million shares of common stock remained available for issuance and sale under the sales agreement. Share Repurchase Program On November 15, 2012, the Company announced that its board of directors had authorized the repurchase of shares of the Company's common stock having an aggregate value of up to $250 million. For the year ended December 31, 2013, the Company repurchased 13.6 million shares with a weighted average purchase price of $8.49, or approximately $115.7 million in the aggregate. The Company did not make any repurchases during 2012.



7. INCENTIVE COMPENSATION PLAN

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The Company has adopted Incentive Compensation Plans in 2013 ("2013 Plan"), 2012 ("2012 Plan") and 2011 ("2011 Plan") (collective, the "Bonus Plans"). Pursuant to the Bonus Plans the Company pays discretionary bonus awards ("Bonus Awards") to eligible employees. The amount of each employee's Bonus Award is calculated at the discretion of the Compensation Committee of the board of directors (the "Compensation Committee") after consideration of the Company's performance, the employee's bonus target and performance for the applicable fiscal year and the Bonus Pool (as defined in the Bonus Plans) made available for Bonus Awards for the applicable fiscal year. The Compensation Committee has discretion to determine the total amount to be distributed from the Bonus Pool, and, subject to certain restrictions under the Bonus Plans, it also has discretion to determine what portion of each award will be paid in cash and what portion of each award will be paid in shares of restricted common stock of the Company. For the year ended December 31, 2013, the Compensation Committee elected to award the Company's employees an aggregate of $7.3 million in Bonus Awards under the 2013 Plan. Approximately $4.1 million of the aggregate Bonus Award amount was accrued during the fiscal year ended December 31, 2013. The remaining $3.2 million will be paid in shares of restricted common stock to be granted in 2014, with $2.9 million and $0.3 million vesting over a five year and three year period, respectively. For the year ended December 31, 2012, the Compensation Committee elected to award the Company's employees an aggregate of $8.5 million in Bonus Awards under the 2012 Plan. Approximately $4.6 million of the aggregate Bonus Award amount was paid in cash in 2012 and was accrued during the fiscal year ended December 31, 2012. The remaining $3.9 million was paid in shares of restricted common stock granted in 2013, with $3.7 million and $0.2 million vesting over a five year and three year period, respectively. For the period from September 1, 2011 to December 31, 2011, the Compensation Committee elected to award the Company's employees an aggregate of $2.5 million in Bonus Awards under the 2011 Plan. Approximately $0.5 million of the aggregate Bonus Award amount was paid in cash in 2012 and was accrued during the fiscal year ended December 31, 2011. The remaining $2.0 million was paid in shares of restricted common stock granted in 2012, with $0.1 million and $1.9 million vesting over a three year and five year period, respectively. 8. STOCK OPTIONS AND RESTRICTED COMMON STOCK On May 10, 2013, the Company's stockholders approved the 2013 Equity Incentive Plan (the "Equity Incentive Plan") that provides for the grant of non-qualified common stock options, stock appreciation rights, restricted common stock and other share based awards. As of December 31, 2013 the Company has only granted restricted common stock pursuant to the Equity Inventive Plan. The Compensation Committee administers the Equity Incentive Plan. Awards under the Equity Incentive Plan may be granted to the Company's directors, executive officers and employees and other service providers. The Equity Incentive Plan authorizes a total of 8,500,000 shares that may be used to satisfy awards under the plan. As of December 31, 2013 the remaining shares to be granted under the Equity Incentive Plan were 8,474,198. Prior to May 10, 2013, the Company had a stock incentive plan (the "2006 Stock Incentive Plan") in place that provided for the grant of non-qualified common stock options, stock appreciation rights, restricted common stock and other share based awards. Following stockholder approval of the Equity Incentive Plan the Company could no longer make awards under the 2006 Stock Incentive Plan. Under the 2006 Stock Incentive Plan the Company only granted qualified common stock options and restricted common stock. The Compensation Committee administered the plan. Awards under the 2006 Stock Incentive Plan were granted to the Company's directors, executive officers and employees and other service providers. Restricted common stock granted to non-employee directors prior to January 1, 2014 vests over a one-year period. Effective January 1, 2014, all restricted common stock granted to non-employee directors, including the restricted common stock granted on January 2, 2014, will vest at the end of the quarter in which it was granted. A description of the vesting schedules for restricted common stock granted to the Company's executive officers and employees is included in note 7-"Incentive Compensation Plan". The following table summarizes restricted common stock transactions for the years ended December 31, 2013, 2012 and 2011: 75



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Years ended December 31, 2011, 2012 and Officers and 2013 Employees(1) Directors Total Unvested Restricted Common Stock as of December 31, 2010 754,001 22,356 776,357 Granted (Weighted average grant date fair value $13.21) 150,000 34,446 184,446 Canceled/Forfeited (3,917 ) - (3,917 ) Vested (355,414 ) (28,356 ) (383,770 ) Unvested Restricted Common Stock as of December 31, 2011 544,670 28,446 573,116 Granted (Weighted average grant date fair value $13.38) 181,618 31,668 213,286 Canceled/Forfeited (38,387 ) - (38,387 ) Vested (113,781 ) (28,446 ) (142,227 ) Unvested Restricted Common Stock as of December 31, 2012 574,120 31,668 605,788 Granted (Weighted average grant date fair value $11.91) 319,979 44,765 364,744 Canceled/Forfeited (39,034 ) - (39,034 ) Vested (135,438 ) (31,668 ) (167,106 ) Unvested Restricted Common Stock as of December 31, 2013 719,627 44,765 764,392 ______________



(1) Include grants to the Company's executive officers and certain officers

and employees of the Manager prior to Internalization.

Unrecognized compensation cost related to unvested restricted common stock granted as of December 31, 2013 and 2012 was $8.0 million and $7.1 million, respectively, assuming no forfeitures due to the small number of employees and historical employee attrition. The total fair value of restricted common stock awards vested during the years ended December 31, 2013, 2012 and 2011 were $1.8 million, $2.3 million and $5.1 million, respectively, based upon the fair market value of the Company's common stock on the vesting date. There were no common stock options granted during the years ended December 31, 2013, 2012 and 2011. As of December 31, 2013 and 2012, there were 131,088 options outstanding, all of which were vested and exercisable, with a weighted average exercise price of $30.00, expiration date of February 2016 and fair value of $0.00 per option. The components of share based compensation expense for each period were as follows (in thousands): Year ended December 31, 2013 2012 2011 Restricted shares granted to officers and employees(1) $ 3,024$ 2,440$ 4,848 Restricted shares granted to certain directors 447 394 415 Total shared based compensation expense $ 3,471 $



2,834 $ 5,263

_________

(1) Includes grants to employees of the Company's manager prior to the Internalization. 9. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS On September 1, 2011, the Company acquired certain assets and entered into agreements to effect the Internalization. Prior to the Internalization, the Company had been managed by the Manager pursuant to the Management Agreement. The Manager had entered into sub-advisory agreements with Sharpridge and an affiliate of The Cypress Group, pursuant to which the Manager was provided with all of the resources and assets used to operate the Company's business and manage the Company's assets. In connection with the completion of the Internalization, the Management Agreement, sub-advisory agreements and other ancillary agreements related thereto were terminated. No termination fee was incurred or paid as a result of terminating those agreements. The Management Agreement provided, among other things, that the Company pay to the Manager, in exchange for managing the day-to-day operations of the Company, certain fees and reimbursements, consisting of a base management fee and reimbursement for out-of-pocket and certain other costs incurred by the Manager and on behalf of the Company. The base management fee, which was paid monthly, was equal to 1/12 of (A) 1.50% of the first $250,000,000 of Net Assets (as defined in the Management Agreement), (B) 1.25% of such Net Assets that are greater than $250,000,000 and less than or equal to $500,000,000, and (C) 1.00% of such Net Assets that are greater than $500,000,000. The Company was also required to 76



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reimburse the Manager for its pro-rata portion of rent, utilities, legal and investment services, market information systems and research publications and materials. In addition, the Company recognized share based compensation expense related to common stock options and restricted common stock granted to the Company's executive officers and affiliates of the Manager, which is included in compensation and benefits on the statement of operations. For the year ended December 31, 2011 the Company incurred the following in base management fees and expense reimbursement (in thousands): Year ended December 31, 2011* Base Management Fees $ 7,835 Expense Reimbursement 607 Total $ 8,442 ________



* Expenses were only incurred during the period from January 1, 2011 to August 31, 2011.

10. INCOME TAXES The Company has elected to be taxed as a REIT under Section 856 of the Code and intends to continue to comply with the provisions of the Code. As a REIT, the Company generally is not subject to federal or state income tax. To maintain its qualification as a REIT, the Company must distribute at least 90% of its REIT taxable income to its stockholders each year and meet certain other tests relating to assets and income. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax on its taxable income at regular corporate rates. The Company may also be subject to certain state and local taxes. Under certain circumstances, even though the Company qualifies as a REIT, federal income and excise taxes may be due on its undistributed taxable income. No provision for income taxes has been provided in the accompanying financial statements related to the REIT because the Company has paid or will pay dividends in amounts that exceed at least 90% of its current year taxable income. Book/tax differences primarily relate to amortization of realized losses on the termination of swaps, share based compensation expense and unrealized appreciation (depreciation) on investments and interest rate swaps and caps. The per share tax character of the common, Series A Preferred Stock and Series B Preferred Stock distributions declared to stockholders in 2013 of $1.32, $1.9375 and $0.859375, respectively, is estimated to be $0.85, $1.9375 and $0.859375 ordinary income, respectively, and $0.47 return of capital to the Company's common stockholders. The estimated federal tax cost and the tax basis components of distributable earnings were as follows (in thousands): As of December 31, 2013 Cost of investments $ 13,930,216 Gross appreciation $ 58,432 Gross depreciation (122,855 )



Net unrealized appreciation (depreciation) $ (64,423 ) Undistributed ordinary income

$ - Capital loss carryforwards $ 602,474 As of December 31, 2013, the Company's estimated capital loss carryforwards available to offset future realized gains are subject to current and future limitations in accordance with Internal Revenue Code section 382 and expire as follows (in thousands): December 31, 2014 $ 48 December 31, 2018 602,426 Total $ 602,474



As of December 31, 2013 and 2012, the Company had no undistributed taxable income. Tax years from 2010 through 2013 remain open to examination by U.S. federal, state and local, or non-U.S. tax jurisdictions. No income tax provision was recorded for the Company's open tax years.

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11. COMMITMENTS AND CONTINGENCIES The Company has leased office space in which the term expires on June 30, 2016. The lease has been classified as an operating lease. The rental expense for the year ended December 31, 2013, 2012 and 2011 was $0.4 million, $0.4 million and $0.2 million, respectively. Under this agreement, annual rental payments will be as follows throughout the term of the lease for the years ending December 31 (in thousands): 2014 $ 293 2015 262 2016 131 $ 686 The Company enters into certain contracts that contain a variety of indemnifications, principally with broker dealers. As of December 31, 2013 and 2012, no claims have been asserted under these indemnification agreements. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2013 and 2012. 12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK OR CONCENTRATIONS OF CREDIT RISK In the normal course of its business, the Company trades various financial instruments and enters into various investment activities with off-balance sheet risk, including interest rate swap contracts. These financial instruments contain varying degrees of off-balance sheet risk whereby losses resulting from changes in the fair values of the securities underlying the financial instruments or the Company's obligations thereunder may ultimately exceed the amount recognized in the statement of assets and liabilities. The notional amounts of the swap and cap contracts do not represent the Company's risk of loss due to counterparty nonperformance. The Company's exposure to credit risk associated with counterparty nonperformance on swap or cap contracts is limited to the difference between the fair value of the swap and cap plus any accrued interest, minus the fair value of collateral pledge plus any accrued interest. The Company is also subject to credit risk associated with counterparty non performance on repurchase agreements. The Company's exposure to credit risk associated with counterparty nonperformance on repurchase agreements is limited to the difference between the borrowings under repurchase agreements plus any accrued interest, minus the fair value of collateral pledge plus any accrued interest. Any counterparty nonperformance of these transactions is not expected to have a material effect on the Company's financial condition. The Company's investments are primarily concentrated in securities that pass through collections of principal and interest from underlying mortgages, and there is a risk that some borrowers on the underlying mortgages will default. Therefore, mortgage-backed securities may bear some exposure to credit losses. However, the Company mitigates credit risk by primarily holding securities that are either guaranteed by government (or government-sponsored) agencies. The Company bears certain other risks typical in investing in a portfolio of mortgage-backed securities. The principal risks potentially affecting the Company's financial position, results of operations and cash flows include the risks that: (a) interest rate changes can negatively affect the fair value of the Company's mortgage-backed securities, (b) interest rate changes can influence borrowers' decisions to prepay the mortgages underlying the securities, which can negatively affect both cash flows from, and the fair value of, the securities, and (c) adverse changes in the fair value of the Company's mortgage-backed securities and/or the inability of the Company to renew short term borrowings under repurchase agreements can result in the need to sell securities at inopportune times and incur realized losses. The Company enters into derivative transactions with counterparties as hedges of interest rate exposure and in the course of investing. In the event of nonperformance by a counterparty, the Company is potentially exposed to losses, although the counterparties to these agreements are primarily major financial institutions with investment grade ratings. The Company is subject to interest rate risk. Generally, the value of fixed income securities will change inversely with changes in interest rates. As interest rates rise, the market value of fixed income securities tends to decrease. Conversely, as interest rates fall, the market value of fixed income securities tends to increase. The Company's principal trading activities are primarily with brokers and other financial institutions located in North America. All securities transactions of the Company are cleared by multiple major securities firms pursuant to customer agreements. At December 31, 2013 and 2012, substantially all the investments in securities and receivable for securities sold are positions with and amounts due from these brokers. The Company had substantially all of its individual counterparty concentrations with these brokers and their affiliates. 78



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13. FINANCIAL HIGHLIGHTS In accordance with financial reporting requirements applicable to investment companies, the Company has included below certain financial highlight information for the years ended December 31, 2013, 2012 and 2011: Per Common Share Year Ended December 31, 2013 2012 2011 Net asset value, beginning of period $13.31$13.02$11.59 Net income (loss): Net investment income 1.51 (a) 1.63 (a) 2.39 (a) Net gain (loss) from investments and swap and cap contracts (4.30) (a) 1.03 (a) 1.27 (a) Net income (loss) (2.79) 2.66



3.66

Dividends on preferred shares (0.09) (a) (0.02) (a) 0.00 (a) Net income (loss) available to common shares (2.88) 2.64



3.66

Capital transactions: Distributions on common shares (0.85) (2.37)



(1.96)

Tax return of capital distributions (0.47) 0.00



(0.29)

Issuance/Repurchase of common and preferred stock and amortization of share based compensation 0.13 (a) 0.02 (a) 0.02 (a) Net decrease in net asset value from capital transactions (1.19) (2.35)



(2.23)

Net asset value, end of period $9.24$13.31



$13.02

Net asset value total return (%) (20.66 )% 20.43 % 31.75 % Market value total return (%) (b) (27.36 )% 7.63 % 21.22 % Ratios to Average Net Assets Expenses before interest expense 0.98 % 1.05 % 2.34 % Total expenses 3.44 % 3.30 % 4.24 % Net investment income 12.04 % 11.66 % 19.30 % __________________



(a) Calculated based on average shares outstanding during the period. Average

shares outstanding include vested and unvested restricted shares and differs from weighted average shares outstanding used in calculating EPS (see Note 3).



(b) Calculated based on the change in market value of the Company's common

shares taking into account dividends reinvested in accordance with the terms of the DSPP. 14. SUBSEQUENT EVENTS On January 1, 2014, an aggregate of 15,246 shares of restricted common stock were granted to certain directors as a portion of their compensation for serving on the Company's board of directors. The CPR of the Company's Agency RMBS portfolio was approximately 5.9% and 5.3% for the month of January 2014 and February 2014, respectively. Effective January 1, 2014, the Company discontinued its application of Topic 946. Upon transition, management elected the Fair Value Option ("FVO") under ASC 825 for all investments held. As a result of the FVO election, all changes in the fair value of investments held on January 1, 2014 will continue to be recorded in the Company's statement of operations. In addition, the Company has elected not to designate its derivatives as hedging instruments in accordance with ASC 815. As a result, all changes in the fair value of derivative instruments held on January 1, 2014 will also continue to be recorded in the Company's statement of operations. Discontinuance of Topic 946 accounting will change the presentation of the Company's financial statements prospectively, the most significant of which are as follows: 79



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(i) the removal of the schedule of investments and financial highlights,

(ii) reformatting of the balance sheet to a consolidated balance sheet presentation, (iii) reformatting of the statement of operations with the inclusion of the statement of comprehensive income (loss) as applicable, (iv) the removal of the statement of changes in net assets and inclusion of a statement of changes in stockholders' equity, (v) reformatting of the statement of cash flows with the inclusion of an investing section, and (vi) changes to certain footnotes to reflect conformity with applicable U.S. GAAP for non-investment companies, including summary information on the amortization/accretion of bond premium/discounts.



15. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Three Months



Ended

(in thousands except per share numbers) December 31, 2013 September 30, 2013 June 30, 2013 March 31, 2013 Total investment income $ 91,743 $ 85,636 $ 81,551$ 73,101 Total expenses 15,930 17,566 19,718 20,584 Net investment income 75,813 68,070 61,833 52,517 Net gain (loss) from investments (190,321 ) 15,781 (656,295 ) (78,811 ) Net gain (loss) from swap and cap contracts 22,644 (53,280 ) 196,176 10,091 Net income (loss) $ (91,864 ) $ 30,571 $ (398,286 )$ (16,203 ) Dividend on preferred shares (5,203 ) (5,203 ) (3,995 ) (1,453 ) Net income (loss) available to common shares $ (97,067 ) $ 25,368 $ (402,281 )$ (17,656 ) Net income (loss) per common share basic & diluted $ (0.59 ) $ 0.14 $ (2.32 )$ (0.10 ) Three Months Ended (in thousands except per share numbers) December 31, 2012 September 30, 2012 June 30, 2012 March 31, 2012 Total investment income $ 79,579 $ 76,631 $ 71,747$ 65,369 Total expenses 21,165 17,233 14,272 11,972 Net investment income 58,414 59,398 57,475 53,397 Net gain (loss) from investments (95,994 ) 221,127 68,586 33,150 Net gain (loss) from swap and cap contracts (2,363 ) (38,618 ) (24,356 ) (17,429 ) Net income (loss) $ (39,943 ) $ 241,907 $ 101,705$ 69,118 Dividend on preferred shares (1,452 ) (953 ) - - Net income (loss) available to common shares $ (41,395 ) $ 240,954 $ 101,705$ 69,118 Net income (loss) per common share basic & diluted $ (0.24 ) $ 1.46 $ 0.87 $ 0.66 80



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